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February 2015

Cost of Capital: 2015 Outlook

More than 1,700 people listened in January as a group of project finance industry veterans
talked about the current cost of capital in the tax equity, bank debt, term loan B and project
bond markets and what they foresee for the year ahead.
The panelists are John Eber, managing director and head of energy investments at
JPMorgan Capital Corporation, Jack Cargas, managing director in renewable energy at Bank
of America Merrill Lynch, Thomas Emmons, managing director and head of renewable energy
finance for the Americas at Dutch bank Rabobank, Jean-Pierre Boudrias, vice president and
head of project finance at Goldman Sachs, Steven Greenwald, a senior advisor in project
finance at Credit Suisse, and Jerry Hanrahan, vice president and team leader in the power &
infrastructure, bond & corporate finance group at John Hancock. The moderator is Keith
Martin with Chadbourne in Washington.
MR. MARTIN: John Eber, what was the tax equity volume in 2014? How did it break down
among wind, utility-scale solar and rooftop solar?

Tax Equity
MR. EBER: We were able to get a pretty good handle on the wind tax equity market. It is
more challenging with solar, and the solar numbers are still being gathered.
For wind, 29 deals came to market last year. We track on the basis of deals being awarded
rather than when they closed. The deals amounted to almost 6,000 megawatts of wind and
close to $5.8 billion of tax equity. There were 19 tax equity investors in wind.
/ continued page 2

Cost of Capital: 2015 Outlook

12 Yield Cos: State of Play

22 Egypts Feed-In Tariff Program:
Ready, Set...
28 Community Solar Models
and Risks
32 Crowdfunding: Good Way
to Raise Capital?
42 Falling Oil Prices and Upstream
Insolvency Risk
49 An Expanding US P3 Market
57 Current Trends: Industry Chatter


OFFSHORE INVESTMENT FUNDS are up in arms over an internal memo

the Internal Revenue Service released in January.

The memo said that an offshore fund using an independent agent

with an office in the United States to make regular loans to US borrowers

and underwrite equity issuances by placing the equity with both US and
foreign persons is engaged in a US trade or business. That means the fund
would be subject to US corporate income taxes at a 35% rate plus possibly
a branch profits tax for another 30% of the remaining earnings, for a total
tax on its US earnings of as much as 54.5%.

The IRS memo is Chief Counsel Advice 201501013.

It discusses a fund that was formed in a country / continued page 3

66 Environmental Update
This publication may constitute attorney advertising in some jurisdictions.

Cost of Capital
continued from page 1

That is sizable growth in the market last year compared to

2013 when we saw about $3.5 billion in wind. It is one of the
larger years for wind tax equity that we have seen in some time.
The solar market could end up being comparable in size. Last
year, solar was slightly larger than wind. It is more difficult to
compile the final figures so early after the start of the new year.
MR. MARTIN: Do you have a feel for whether most of the solar
activity was in rooftop solar or utility scale?
MR. EBER: I think it is similar to 2013 when we saw a significant
amount of activity in rooftop; it accounted for about a third of
the tax equity volume in solar. It would not surprise me to see
the same breakdown in 2014.
MR. MARTIN: In 2013, there was something like $6.5 billion in
total tax equity. You are talking about a very significant increase
in volume over 2013.
MR. EBER: Without a doubt, there was a significant increase
over 2013, certainly in the wind sector. If you recall, wind started
out slowly in early 2013 because the extension of production tax
credits came literally on January 1. It took a while for the market
to ramp up in the first half of the year.

There were almost 50% more tax equity

in 2014 than 2013.

MR. MARTIN: The trend has been for solar to exceed wind in
volume. If that happened last year, then you are talking about an
$11.6 tax equity market in 2014, which would just be a phenomenal size.
MR. EBER: I am not predicting that that is what happened last
year, but there was a sizeable solar market in 2014. Whether it
will end up having exceeded wind remains to be seen.
MR. MARTIN: How does 2015 look?


F EB R UA RY 2015

MR. EBER: My sense is 2015 will be a very strong year, especially

after Congress extended the deadline to start construction of
new wind farms through the end of 2014 to qualify for tax
credits. Solar was going to be a strong year regardless because
the entire solar market has been working toward a deadline of
the end of 2016 to qualify for the investment tax credit. We are
as busy as we have ever been right now working on prospective
opportunities and expect 2015 to be an extremely active year in
both solar and wind tax equity.
MR. MARTIN: When do you think people need to be talking to
you about 2015 deals to have any hope of having your attention
to close this year?
MR. EBER: There is still plenty of time.
MR. MARTIN: Jack Cargas, the same?
MR. CARGAS: Yes, but we encourage people to alert us to possible 2015 transactions early in the year. The entire tax equity
market saw a significant back-end weighting of transactions in
2014 to the fourth quarter. There was tremendous pressure on
everyones time, and that is not only on the time of the investors,
but also sponsors, external counsel and third-party experts. The
pressure on human resources last year was extreme.
MR. EBER: I agree with Jack. The bottleneck is with due diligence. There was a notable bottleneck toward the end of last
year getting the independent
engineering resources to complete diligence.
One reason I think 2015 will be
strong is we saw plenty of deals
last year that did not really need
to close until 2015. We asked
folks to be a little patient with us,
and we would try to take them
up this year versus tying up time
last year when we were so busy
with other closings.
MR. MARTIN: Moving rapidly
through a series of questions, tax equity yields have been fairly
stable over the last four or five years, but they seem to be creeping up lately due to the addition of commitment or structuring
fees on the front end and use of higher, 20-year yield targets on
top of the flip yield at the back end. Do you agree with that
MR. EBER: There is a lot more competition in the market than
before because we have more investors now. The 19 investors

that we saw last year in wind is an increase over what we saw

the year before.
MR. MARTIN: That would normally bring yields down if you
have more supply, correct?
MR. EBER: Yes, it should. We are talking about deals that are
mainstream deals, meaning deals with leading sponsors, tier-one
suppliers of equipment and long-term fixed-price power purchase agreements.
MR. MARTIN: Lance Markowitz said on this call last year that
he thought yields for the benchmark wind deals, meaning with
the largest sponsors, were 50 basis points above or below 8%
unleveraged. That band may be a little wide. What we have seen
ourselves is a band of perhaps 20 basis points below to 25 basis
points above 8%. How many basis points would you say we are
up or down this year compared to last year?
MR. EBER: The market pricing continues to be very stable.
MR. MARTIN: Jack Cargas, agree?
MR. MARTIN: How common are structuring or commitment
fees at the front end or unused commitment fees at the back
end on top of the yield?
MR. CARGAS: We are seeing more of that in our shop, in particular in transactions that include a forward commitment of
capital. An example is wind deals that commit capital forward
in order to accommodate construction financing. Another
example is residential solar funds where there are multiple draws
over time. Both kinds of transactions often include up-front
structuring fees. Turning to back-end non-utilization fees, those
are also common in residential and commercial and industrial
solar funds. Once an investor decides that a program is a worthwhile investment, it would like to see its capital deployed.
MR. MARTIN: John Eber, we have seen such fees all over the
map. Fees might range from 37.5 basis points to 75 or 100 basis
points. There does not seem to be a market level of fee.
MR. EBER: They can vary depending on what is happening in
the deal. If a lead investor is providing a significant amount of
advisory work and services to the other investors and there is a
long-term commitment by all of the investors, then you are more
likely to see fees at the high end of the range.
If no advisory or support services are required from the lead
investor, but there is a long-term commitment, then you might
see an up-front fee at the lower end of the range.
MR. MARTIN: What is considered long term for a
/ continued page 4

outside the US. The country did not have a tax

treaty with the United States. If it did, then the
fund might limit any US tax on its earnings to a
possible withholding tax on interest and
dividends at the US border, as long as the fund
does not have a permanent establishment in
the United States.

The fund is a partnership for US tax purposes.

A feeder fund immediately above it is a corporation for US tax purposes. Both are organized in
the same country, probably the Cayman Islands.

The fund has no employees. It relies on an

independent agent that originates all its deals,

negotiates them and does diligence. The agent
has an office in the US. It does similar work for
other funds.

The fund regularly makes loans to US

borrowers and also engages in underwriting of

equity interests. It enters into distribution
agreements committing to buy up to a fixed
dollar amount of shares for resale. There is a
notice period: the fund buys the shares within
an agreed number of days after notice from the
client, and it arranges during the notice period
to place all the shares. The stock is bought at a
discount from current market and then resold at
market. The fund also earns fees on both the
loans and the underwriting.

Under the US tax code, any foreign corpora-

tion that engages in a US trade or business must

pay full US corporate income taxes on its income
from that business. Partners in partnerships are
treated as if they engaged directly in any business
in which the partnership engages.

There is no clear line for what is considered

a trade or business. Activities undertaken for

profit are a trade or business if they are considerable, continuous, and regular.

The IRS said in the memo that business that

a foreign person does through an agent is treated

as if done by the foreign person directly, regardless of the degree of control the foreign person
exercises over the agent.
/ continued page 5

FE B RUA RY 2015


Cost of Capital
continued from page 3

MR. EBER: A commitment of 12 months or into the next tax

year could be considered long term.
MR. MARTIN: What is the current spread between yields in the
benchmark wind deals versus utility-scale and rooftop solar?
MR. EBER: We dont see much of a difference in our shop on
MR. MARTIN: Among all three?
MR. EBER: Between utility-scale solar and wind.
MR. MARTIN: When you get to distributed solar, is the spread
100 basis points higher, 150, 75?
MR. EBER: Those deals are not very homogenous, so they are
difficult to talk about in generalities, especially as it pertains to
MR. CARGAS: There can be a meaningful spread between wind
yields and solar yields, but yield is really only one of the metrics
by which we and other investors compare these investments.
There are different structures potentially and different repayment profiles both from a tax and cash perspective. Obviously
wind deals have 10 years of PTCs, and sometimes they have a
cash reversion period. Solar deals have an ITC on day one that is
a significant part of the yield. Some deals are inverted leases with
a constant coupon.
The point is that yield is interesting, but it is not the be all and
end all. It is not the only method that we use in evaluating these
investments and, frankly, it is not the only thing that sponsors
should consider when contemplating structures and pricing.
MR. MARTIN: John Eber has made the same point repeatedly
on many calls and panels that we have done together.

Downward pressure remains on interest

with 94 active banks chasing deals.


F EB R UA RY 2015

How much of a yield premium should one expect currently if

one adds leverage, meaning that the tax equity is behind a lender
in the capital stock?
MR. EBER: We are seeing few leveraged tax equity deals, certainly very few in the wind space and not much more in the solar
market. The tax equity will clearly require a premium because it
has a greater risk of not reaching its return. The premiums run a
few hundred basis points, but there are so few leveraged deals
today that it is impossible to say what is market.
MR. MARTIN: What do you consider market for lender forbearance where there is leverage? Or is there no market at this
MR. EBER: We have not seen much. In solar where there has
occasionally been leverage, anybody on the tax equity side would
want forbearance at a minimum through the recapture period
for the ITC.
MR. MARTIN: Forbearance means the lenders would have
normal remedies after a payment default, but could not take the
asset for non-payment defaults? All they could do in such a situation is push out the sponsor?
MR. EBER: Right. You would want a minimum of five-year
forbearance if you are willing to go into one of those deals in the
first place.
MR. CARGAS: I think one of the reasons why we are not seeing
that much leverage is because lenders are loathe to agree to
those sorts of forbearance provisions. None of the leveraged solar
deals was an ITC deal; they were Treasury cash grant deals, and
those are mostly out of the picture now.
MR. EBER: If there were a wind deal, then you would want
10-year forbearance because that is the PTC period. That would
be an even a bigger lift.
MR. MARTIN: John Eber, you
said there were 19 active tax
equity investors in the wind
sector last year. Do you have a
feel for how many there were in
the solar sector?
MR. EBER: We counted 25 in
solar. We are seeing somewhere
around 28 to 30 between both
sectors. Many play in both
markets. A limited number will
only participate in one or the
other. In addition to the 28 to 30
active tax equity investors,

others are looking at entering the market. This is what one would
expect as the economy improves. More companies start paying
taxes and look to come back into the market.
MR. MARTIN: Do you see the solar rooftop market moving
more in the direction of inverted leases, rather than partnership
flips and sale leasebacks, and, if so, what do you think is driving
that shift?
MR. CARGAS: We know that some market participants have
a preference for inverted leases for solar, but we are not sure we
have seen a huge shift. To the extent that there has been some
movement in that direction, it may stem partly from new guidelines the IRS issued for transactions involving tax credits for
renovating historic buildings in early 2014. Those guidelines
suggested the IRS is okay with the inverted lease structure, at
least in historic tax credit deals. Some players have concluded
that that is de facto guidance for solar.
We maintain a preference in our shop for partnerships and
regular leases.
MR. EBER: I generally agree with Jack. Many of the sponsors to
whom we are talking have a preference for the partnership flip.
That seems the more prevalent structure from our observations,
although there are a number of solar investors who will only do
inverted leases.
MR. MARTIN: How comfortable is the tax equity market with
wind projects that relied on physical work at the project site or
a factory to be under construction in time to qualify for tax
MR. EBER: I think most of the market has become comfortable
with physical work cases given that we have now had three
rounds of guidance from the IRS. We think the accumulated
guidance is fairly comprehensive.
MR. MARTIN: Let me drill down a bit briefly. Some developers
dug several holes for turbine foundations before year end, and
then went back to basic development work on their projects.
Some developers ordered a transformer and there was limited
physical work at the factory before year end. Are you okay with
those cases?
MR. EBER: It will turn on the facts in each case. Lets just say
that I think the sponsors have been very responsible in trying to
establish clearly that they began physical work, and there is a
range of fact patterns on offer in the market. The more work that
was done, the better chance you have of attracting a broad
spectrum of tax equity to a transaction. The closer you are to the
low end of the requirements, the more challenging it will be to
/ continued page 6
raise tax equity.

The fund in this case engaged in a steady

stream of US transactions.

The fund argued that it was shielded from

being viewed as engaged in a US trade or business

by two trading safe harbors.

One shields foreigners who are merely

trading in stock or securities through a resident

broker, commission agent, custodian, or other
independent agent. The foreign person cannot
effect the trades through an office in the US.

The IRS said this safe harbor does not apply

because the fund is engaged in a banking business

rather than trading. Trading is purchasing and
selling in secondary markets in order to profit from
changes in value of the traded securities, the IRS
said. A trader does not earn fees or a price markup
in exchange for services.

The IRS said it also thinks the fund is acting

through a US office. An independent agents

office is not usually treated as belonging to
someone who hires the agent, but the IRS said
this agent is not independent because it has
been delegated too much discretionary authority
to run the deals.

The other safe harbor shields foreigners

who are merely trading stocks and securities for

their own accounts. It does not matter whether
such a taxpayer trades directly or through an
agent. It does not matter how much discretionary
authority the agent has to make decisions, and it
does not matter whether the foreign person
trades through an office in the US. However, a
dealer in stocks or securities cannot use this
safe harbor, as he is considered to be engaging in
a business rather than merely investing for his
own account. Under IRS rules, a foreign person is
not a dealer if he underwrites securities by
placing them solely with foreign purchasers or if
the agent is merely investing funds belonging to
a particular customer, such as where a foreign
bank engages as US agent to invest funds of a
particular customer in the US.

The IRS said this fund is a dealer and is not

merely investing for its own account. Moreover,

it resells the underwritten

FE B RUA RY 2015

/ continued page 7


Cost of Capital

under half of the market, conventional power was about a

quarter and renewables were just under a quarter.
continued from page 5
MR. MARTIN: How many active banks were there in 2014, and
MR. MARTIN: How comfortable is the market with projects
how many do you expect in 2015?
that were under construction in time because the developer
MR. EMMONS: In 2014, 94 banks played some role in project
incurred at least 5% of the expected cost, but that will not be
finance. That is up 20% from 72 in the previous year. Of course,
completed until after 2016?
that is the whole universe, including a lot of banks who had low
MR. CARGAS: Thats a tough question. We are not fully ready
levels of activity. A better measure is the number of major
to address 2017 because we are still concerned about 2016. We
lenders. In 2014, 49 banks committed more than $200 million in
want to see clear guidance from the IRS that the extension of
aggregate each, and that is up about 20% from 2013. Not only is
the construction-start deadline to the end of 2014 also had the
the market growing in total participants, but the big guys are
effect of giving developers through the end of 2016 to complete
also putting out more money.
projects without having to prove that they worked continuously
Predictions about the year ahead are always difficult. There
on the projects.
will no doubt be new entrants, but we are nearing 100 banks
and already have plenty of
players. I think what will happen
is that the current lenders will
step up with additional capacity
to meet the demand because
Bank margins can be as low as 150 basis points
those banks still have capacity,
MR. MARTIN: When you say
over LIBOR, with most of the market sticking
step up to meet the demand, it
sounds like you are suggesting
to tenors under 10 years.
that demand for capital to fund
new projects in North America is
MR. EMMONS: There was
increasing demand in the last two
Some participants appear to be assuming that there was
years, and the banks stepped up. The bank market is adequately
already such a back-end extension, but we would like to see it in
liquid, and there are enough players that the bank market can
writing from the IRS and, until that happens, we are not even
adapt to additional market demand. We remain in a situation
thinking yet about 2017.
where there are plenty of banks and plenty of liquidity. If there is
MR. EBER: That is a very good summary. We are anxiously
more demand in 2015, the banks will be able to handle it.
awaiting confirmation from the IRS as is the rest of the market.
MR. MARTIN: It is always a question who has the edge in
negotiations. The big story last year was there were so many
Bank Debt
banks chasing product that there was downward pressure on
MR. MARTIN: Turning from tax equity to bank debt, Tom
rates. Is demand increasing faster than supply, or will we remain
Emmons, what was the North American project finance bank
in an oversupply situation?
market in 2014 compared to 2013?
MR. EMMONS: We remain in an oversupply situation. There is
MR. EMMONS: Volumes were up significantly in 2014 comstill downward pressure on rates. As I mentioned, there are more
pared to 2013: 45% from a $28 billion market in 2013 to $41
lenders, the market is liquid, the market is competitive, banks
billion in 2014. I am drawing on data compiled by Infrastructure
have lower funding costs, and there are more short-term faciliJournal. The US was dominant, comprising about 80% of the
ties. The banks are not being asked to do the heavy lifting of
North American project finance market, Canada about 15%, and
long-term loans.
Mexico the balance. In terms of sectors, oil and gas was just


F EB R UA RY 2015

However, I think most of the rate reduction is behind us. Banks

now are often bidding at the minimums in their return models.
When you look at this from the perspective of cycles, we are now
at margins that are roughly where they were in 2008. It is hard
to see how they can fall a lot farther. That said, there is liquidity
and there still is downward pressure. The bottom line is it
remains a borrowers market.
MR. GREENWALD: A lot of the increase in the size of the market
came from just a handful of mega transactions that took place
in the oil and gas space, notably Sasol and the Freeport transactions in the last quarter of last year. We should see some more
mega transactions this year.
MR. EMMONS: If you look at subsectors, apart from oil and
gas, some interesting trends emerge. US solar doubled to $2.5
billion and lending to wind projects declined by about 40%, dropping from $3 billion to $1.8 billion. Conventional power was
about flat.
MR. MARTIN: What is the current spread above LIBOR for interest rates?
MR. EMMONS: There is a wide range, particularly because
different projects present different risks, but to summarize, at
the low end, for clean, short-term, large, well-sponsored deals,
margins can begin as low as 150 basis points above LIBOR, and
sometimes even lower in unusual cases. In the middle, for a
typical moderately-complex medium-sized term loan, somewhere around 200 basis points, plus or minus. At the upper end,
complex and aggressive deals, and back-leveraged debt, can be
in the high twos, maybe even approaching three. In very special
cases, we are looking at something now, about which probably
a lot of people on the call know, that is large, complex and very
unusual, and the pricing for it could even go higher if there is a
need to bring in a lot of lenders.
MR. MARTIN: Is the up-front fee the same as the LIBOR spread?
If the spread is 150 basis points over, the up-front fee is 100 basis
MR. EMMONS: Yes. Typically fees are equal to starting margins.
There can be exceptions.
MR. MARTIN: Steve Greenwald, is it still the case that there is
no LIBOR floor in the bank market?
MR. GREENWALD: That is correct. You still see a LIBOR floor in
the term loan B market, but not in the bank market.
MR. MARTIN: How much movement do you expect in interest
rates this year? Do you think they will remain where they are for
the whole year?

securities to both US and foreign buyers.

Most offshore funds try to avoid a US trade
or business for their lending by acquiring
loans in the secondary market and by engaging in season-and-sell strategies where
securities are held for a period of time before
TREASURY CASH GRANT litigation has started


The US government won the first of a

number of lawsuits against the US Treasury by

renewable energy companies that feel they
should have received larger cash grants under the
section 1603 program. There are another 20
lawsuits pending. Several raise significant issues
of interest to the larger project finance community, including whether part of the purchase price
paid for a power project must be allocated to the
power purchase agreement in situations where
the contracted electricity price is above what can
be earned in the current market.

The oldest lawsuit has been pending since

July 2012. All are pending in the US Court of

Federal Claims. The court decided the first case
in mid-January within weeks after hearing oral
arguments. The others should start to move
this year.

The decided case involved a new power plant

in Lewiston, North Carolina that used biomass to

produce steam and electricity that were sold to
an adjacent Perdue chicken rendering plant.
Congress directed the US Treasury, starting in
2009, to pay owners of new facilities that use
renewable energy to generate electricity 30% of
the eligible cost in cash as an alternative to tax
credits during a period when there were concerns
that the tax equity market had collapsed.

The owner of the biomass power plant

applied for a cash grant of $2,711,311. The

Treasury only paid $943,754. It allocated the
project cost between the parts of the project that
produce steam and electricity and paid a grant
only on the part that produces electricity.
/ continued page 9

/ continued page 8

FE B RUA RY 2015


Cost of Capital
continued from page 7

MR. GREENWALD: I expect them to be pretty much where they

are currently. I do not see anything that will move them a whole
lot lower, and I do not see anything that will give banks the
negotiating leverage to push them much higher.
MR. MARTIN: Tom Emmons, what are current loan tenors?
MR. EMMONS: Banks are trying to stay under 10 years for term
loans. There are some exceptions where banks are willing to go
to 18 years, but most of the market is under 10. A lot of deals
today are short-term bridges to tax equity; we just talked about
how tax equity volumes are increasing.
MR. MARTIN: What cash sweep should a borrower expect
during the term of a bank loan?
MR. EMMONS: In a renewable energy deal, typically none,
except there may be some special reason to sweep in a highlystructured deal, perhaps to achieve a particular metric such as a
maturity date or some key ratio for a ratings purpose.
MR. GREENWALD: There are sweeps in some of the very largest
deals, or perhaps not so much sweeps as dividend restrictions.
For example, if you have a $2, $3 or $4 billion bank transaction,
the banks will not want to let a lot of money go out the door to
the equity while waiting for a deadline to be reached when a
huge principal amount has to be refinanced. They will want
incentives to encourage the borrower to complete some of the
refinancing before any distributions can be made to the equity.
MR. MARTIN: What are current debt service coverage ratios
for wind, solar and natural gas projects?
MR. EMMMONS: I can comment on the renewable piece of
that. They are quite stable. Solar is 1.35x, and wind is 1.45x plus
or minus, depending on the circumstances. Those are P50 coverage ratios.
MR. GREENWALD: On natural gas deals, the coverage ratio
tends to be 1.35x at the low end.
MR. MARTIN: What are advance rates on construction debt in
the current market: 85%, 80%, higher, lower?
MR. EMMONS: They can be up to 80% to 90% for
MR. GREENWALD: For other large industrial projects, they can
be as low as in the 50% range, depending on the price risk that
lenders are being asked to assume, all the way up to the mid- and
sometimes high 70% range on the well-structured tolling
arrangements where there is little-to-zero price risk being left to
the lenders.


F EB R UA RY 2015

MR. MARTIN: Yesterday, the Swiss released the cap on the

Swiss franc and let the franc float. It went up 39% in value against
the US dollar. You both work for European banks. What effect, if
any, will this have on the US project finance market?
MR. GREENWALD: I dont see it having much effect.
MR. MARTIN: Tom Emmons, agree?
MR. EMMONS: It should make the US business more valuable
to European banks because the dollars of income coming back
are more valuable. However, most banks that play in this territory
are international and they have US dollar funding desks to match
assets to liabilities, so I dont think it has much effect on how the
European banks play in this market.

Term Loan B
MR. MARTIN: Lets move to the term loan B market. JP Boudrias,
do you have data on the term loan B volume in the power sector
in 2014 and how that volume compared to 2013?
MR. BOUDRIAS: In 2014, we saw about $9 billion of term loan
B compared to $11 billion in 2013. The 2014 deals were almost
entirely power. There were 16 transactions in 2014 compared to
22 in 2013.
MR. MARTIN: Of those 16 projects in 2014, what percentage
were merchant gas-fired powered power plants with power
hedges in PJM and ERCOT?
MR. BOUDRIAS: Seven out of 16 are in that category.
MR. MARTIN: And the balance was what?
MR. BOUDRIAS: The balance was a mix of transactions such
as Atlantic Power and ExGen Renewables that were holdco rather
than opco transactions and renewable deals that tended to have
a bit more contracted revenue.
MR. MARTIN: Earlier this week, a panel I moderated in New
Orleans expressed the view that merchant power plants will
prove financeable in 2015 not only in PJM and ERCOT, but also in
the New England ISO. Do you agree?
MR. BOUDRIAS: That makes sense. When you look at the evolution of how the market has gotten comfortable with quasi-merchant transactions, the first deals were done in ERCOT because of
good visibility on pricing and then moved to PJM where there is
similar visibility and merchant projects can qualify for capacity
payments. Obviously, one of the things that has changed in New
England in recent years is that capacity prices are in much better
shape than they used to be just a few years ago.
MR. MARTIN: For those listening who may not know what a
term loan B loan is, it is basically debt papered as bank debt but
sold to the institutional market.

MR. BOUDRIAS: From a documentation standpoint, it looks

similar to bank debt, but borrowers in the term loan B market
tend to have fewer occasions when one needs to come back to
the lenders for approvals. It is not quite bond documentation as
there are still financial covenants, but a B loan is written so that
there will not have to be a lot future interaction between the
holders of the term loan and the borrower.
From an execution standpoint, these are truly capital markets
transactions. They will be driven by momentum and what is
going on in the broader market, including the ability to place the
paper in the secondary market.
MR. MARTIN: What do you foresee in the term loan B market
in 2015?
MR. BOUDRIAS: It is interesting. When you look at the progression, 2013 saw a lot of refinancing volume. Obviously we entered
2014 with a lot of the refinancing that had to occur already out
of the way. When we look at margins over the course of 2013
and 2014, the trend has generally been up. All of this suggests
less refinancing activity in 2015. Deal supply will be entirely
driven by either new assets that are being brought to market like
transactions that had been financing in the bank market, but the
sponsors are looking for more leverage or want to take a dividend. New construction and M&A may add to deal volume.
To sum up, in 2015 we expect largely similar volumes to what
we saw in 2014. We do not expect significant growth in volume.
MR. MARTIN: Pricing for strong double B credits at this time
last year seemed to be about 275 basis points above LIBOR with
a 1% LIBOR floor and 1 point of original issue discount. For single
B, I think the deals were pricing as much as 500 to 550 basis
points over. What is the current pricing as we head into 2015?
MR. BOUDRIAS: It is comparable. Double B is probably around
350 over with the same 1% floor and issued at 99. Not all single
Bs are created equal, but they are probably circling around 500
basis points over. This pricing is 75 basis points wide of where
we saw levels at the end of 2013.
MR. MARTIN: So it is the opposite of the bank market where
there has been consistent downward pressure on rates. What
accounts for the increasing spreads?
MR. BOUDRIAS: One trend that we saw throughout 2013, but
that was reversed in 2014, was the institutional bank mutual
funds saw inflows for most of 2013. They went for 95 weeks in
a row with positive inflows. Then in 2014, the trend went the
other way. But interestingly, in 2014, we saw record formation
/ continued page 10
of new collateralized loan obligation

The court gave considerable weight to the

Treasurys view as a reasonable interpretation

of the statute. However, it stopped short of
giving the Treasury total discretion because
there is no indication that Congress explicitly or
implicitly delegated broad interpretative authority to the agency. There was no formal rulemaking process by Treasury when it released
guidelines explaining how it plans to pay grants.

The biomass plant owner said the Treasury

already paid it a full grant on another, similar

facility. The government lawyers told the court
the earlier payment was a mistake. The judge said
the Treasury is not bound by a mistake to make
full payments on other plants. The case is W.E.
Partners II, LLC v. United States.

Another suit filed in late December raises the

same issue as the one that the court decided in

January. That suit called GUSC Energy, Inc. v.
United States, involves a new power plant that
GUSC Energy put in service in November 2013 at
an industrial park in Rome, New York that uses
wood chips to produce steam and electricity. The
owner applied for a grant of $5,469,028 and was
paid only $316,609. (The payment would have
been $341,174 but for a 7.2% haircut due to
budget sequestration.) The Treasury paid a grant
solely on the equipment used to generate
electricity, and it also removed costs related to
site cleanup, landscaping, ornamental iron work
and paving.

There is a six-year statute of limitations for

companies who received grants to file suit. Any

government losses in the remaining cases could
lead to more lawsuits.

Meanwhile, Congress fixed a technical error

in the original grant statute. Grants do not have

to be reported by recipients as taxable income.
The original program made this clear for companies that pay regular corporate income taxes, but
not for companies that pay alternative minimum
taxes. The US has two corporate income taxes. A
company computes its taxes under both and pays
essentially whichever amount is higher.
/ continued page 11

FE B RUA RY 2015


Cost of Capital

Project Bonds

continued from page 9

MR. MARTIN: Lets move to project bonds. Jerry Hanrahan, the

project bond market does not do well during periods when the
funds that, by and large, are the largest players in the market,
bank and B loan markets are wide open and looking for product.
probably accounting for 60% of demand in the institutional debt
Was that the story in 2014, and what do you see ahead for 2015?
MR. HANRAHAN: I think thats right. There is lots of liquidity
The difference between the two is that mutual funds have no
in the bank and other markets, and that has traditionally been
real cost of funds, since they are not raising funding to invest,
where most of the project finance deals have gone. Those
whereas CLOs have a cost of funds and will take that into conmarkets have dominated. There were no large syndicated deals
sideration in pricing.
to the private placement market in 2014, but people like ourSo as the mix of investors moves from largely price-insensitive
selves were able to do a few transactions on a more direct and
institutional investors to investors who have a bit of a floor, you
relationship basis.
would expect that would put upward pressure on margins.
That said, the project bond
market remains very deep. There
are probably more than 25 active
MR. MARTIN: Primarily insurance companies?
The term loan B market is 275 to 500 basis points
MR. HANRAHAN: Thats right.
The project bond market can
over LIBOR.
handle large transactions on the
order of $500 million, maybe
even up to $1 billion of capacity
for a well-structured deal.
It is hard to say how much
volume there will be in project
Another thing to keep in mind is this is more capital markets
bonds in 2015. We are not hearing a lot of chatter about deals in
driven. Obviously, there was a good amount of upheaval in late
the pipeline, apart from one fairly significant deal that is in the
2014 with falling oil and gas prices. About 20% of the leveraged
market today.
finance market overall, including the bond market, is exposed to
MR. MARTIN: You need a spark like a fear that interest rates
oil and gas borrowers. There has been a lot of selling pressure as
will rise. Project bonds are fixed-rate long-term debt, unlike
the leveraged finance market has felt over exposed to energy;
floating-rate bank and term loan B loans.
there is pressure get out of that market and go someplace else.
MR. HANRAHAN: Thats right. Many banks are limited in terms
As a point of reference, energy is about 10% of the S&P 500.
of how long they can go, although there are some players that
MR. MARTIN: Is a power hedge essential to financing a merwill go fairly long. The project bond market does not have any
chant power project and, if so, how long a term must it have in
real constraints on tenor other than the underlying creditworthirelation to the loan tenor?
ness of the borrower and the contract that is the source of cash
MR. BOUDRIAS: We have not really seen a lot of pure merchant
transactions. What we see are transactions where there is some
MR. MARTIN: Let me run down a list of what seem to be the
form of price hedge. Probably somewhere around three to four
main differences between bank and term loan B debt, on the
years makes sense. If I tell you any shorter than that, the hedge
one hand, and project bonds on the other. Tell me if any of these
would not provide any real benefit. It has been important to have
items is wrong.
a hedge at least in the early years to reduce price risk.



F EB RUA RY 2015

Tenor: you said you do not have a limit on tenor, but the loan
tenor can usually run as long as the power contract or perhaps
one year short of the PPA term.
MR. HANRAHAN: The tenor generally matches the power
contract. It used to be more common to have the loan run just
short of the power contract term, but these days, the term of the
debt and the PPA term generally match.
MR. MARTIN: There are no up-front fees because the economics are fully baked into the spread. The spread is priced to Treasury
bonds rather than LIBOR. Ratings may be required for widelysyndicated deals, but not for the private or direct placement deals
that you have been discussing. Another key differences is makewhole payments are required if the bonds are repaid ahead of
schedule. Such payments are not required in the bank market.
The project bond market takes construction risk, but will charge
a commitment fee on undrawn capital.
MR. MARTIN: Are there other differences besides the ones I
MR. HANRAHAN: Adding to what you said, ratings are not
required, but the project bond market is investment gradedriven. You might see some small high-yield issuances, but the
market is overwhelmingly investment grade, and that is a big
distinction between ourselves and the bank and term loan B
markets as the bank market tends to be more double B, and the
term loan B market can do things that are even lower rated.
The main differences are the need for an investment-grade
credit and the ability to add tenor to the debt profile.
MR. MARTIN: What is the current spread above Treasuries for
project bonds, and what does it translate into as a coupon?
MR. HANRAHAN: I think the current market is probably somewhere around the mid-200 to 300 basis points over average-life
Treasuries. There has not been a lot of product to test that, but
that is my sense for a well-structured deal. The price can go up
significantly if the borrower is a tougher credit.
Given where we are with Treasury yields, we are at a multi-year
low. That translates into a coupon of around 4.5% currently.
MR. MARTIN: For what may be 20-year fixed-rate debt.
MR. HANRAHAN: Correct. It would not surprise me if the multiyear low that we see today in the Treasury market ends up forcing
some investors to impose minimum coupons over and above
whatever their spread requirements are, but I think you will
generally get to the range I mentioned.

The IRS was starting to lose patience by last

fall after waiting five years for Congress to
fix the error and was starting to collect taxes
from companies that received grants while
they were on the alternative minimum tax.
A tax extenders bill that cleared Congress in
December fixed the error.

own solar and wind projects postponed a public

offering in early February.

The company said it will operate for now

using private capital.

Master limited partnerships are partner-

ships whose units are traded on a stock

exchange or secondary market. Partnerships are
not subject to federal income taxes; rather, each
partner is taxed directly on his share of the
partnerships income. Under US tax law, any
partnership whose units are publicly traded is
taxed like a corporation. A master limited
partnership, or MLP, is a partnership that is able
to retain its status as a partnership, despite
public trading, under a special rule in section
7704 of the US tax code that preserves partnership status as long as at least 90% of the
partnerships income each year comes from
passive sources like interest and dividends
or is income from producing, processing,
refining, transporting or marketing minerals or
natural resources. Wind and sunlight are not
considered natural resources because they are

The company Sol-Wind Renewable

Power, LP planned to use a self-help MLP

structure used by Fortress and Blackstone. (For
a more detailed discussion about the structure,
see A New Structure for MLP Roll-Ups in the
January 2007 NewsWire starting on page 12.)
Sol-Wind said it would have an initial portfolio
of 185.6 megawatts of contracted solar projects
and one contracted wind farm. All of the
projects are in the US, with the exception of 5.9
megawatts of solar in Puerto Rico and 2.9
megawatts of solar in

FE B RUA RY 2015

/ continued page 13



Yield Cos: State Of Play

Six yield cos have been formed to date by large renewable
energy developers in the United States. Many people are curious
about how much yield cos reduce the cost of capital for the
development companies that have formed them, what discount
rates they use to acquire assets, how much room there is for
additional yield cos, what it takes to be able to form one, and
similar questions.
The following is an edited transcript from a well-attended
roundtable discussion about yield cos at the Infocast projects &
money conference in New Orleans in January. The panelists are
Andy Redinger, managing director and group head of utilities,
power and renewable energy at Keybanc Capital Markets and
who contributed to the early buzz about yield cos by being one
of the first investment bankers to write them, Carl WeatherleyWhite, president of LightBeam Electric Company, former head of
project finance at Lehman Brothers and Barclays Capital and
another early proponent of yield cos, Alejandro Burgaleta, chief
financial officer of Gestamp Wind, a Spanish wind developer with
a global footprint that is considering forming a yield co, Hunter
Armistead, executive vice president of Pattern Energy, a prominent US wind company that has reorganized itself as a yield co,
and David McIlhenny managing director of project finance of
SunPower Corporation, a prominent solar developer that has
been debating whether to form a yield co. The moderator is Keith
Martin with Chadbourne in Washington.
MR. MARTIN: David McIlhenny, what is a yield co?
MR. MCILHENNY: A yield co is a synthetic master limited partnership with equity investors who are looking for regular dividends and expect the dividend to grow significantly over time.
One way to maximize how much cash flow is available for

Yield cos are vacuuming up operating

assets at high prices.



F EB RUA RY 2015

dividend payments is to minimize how much taxes the yield co

pays by having the yield co hold projects that throw off as much
in tax shelter as the taxable income they generate.
MR. MARTIN: That is a fairly sophisticated answer. Carl
Weatherley-White, do you want to add to it?
MR. WEATHERLEY-WHITE: A yield co is a company with stable
operating cash flows from long-term contracted assets, that
expects dividends per share to grow over time and that taps
into the public equity market to raise capital at a high multiple
to earnings.
MR. MARTIN: Let me offer another definition. A yield co is a
simple concept. A development company separates its operating
projects from its development pipeline. It puts the operating
projects in a separate corporation that lists on a stock exchange
and is able to raise capital more cheaply because its projects are
de-risked; they have operating histories.
Hunter Armistead, you take issue with these definitions. What
is the problem with what all three of us said?
MR. ARMISTEAD: Anything that starts with the word synthetic
makes me nervous. There are different flavors of yield cos. Is a
yield co a separate company or is it a financing vehicle? Each of
the yield cos that has been formed to date has had a strong
sponsor standing behind the yield co with a healthy development
pipeline that the yield co can buy as a path to future growth.
However, Pattern is a different flavor of yield co than NRG Yield
is. I do not believe all yield cos are the same.
MR. MARTIN: You asked whether a yield co is a company or a
form of financing. By asking this, you are implying, I think, that
there is not much more room in the market for yield cos that are
merely roll ups of assets acquired from third parties; you need a
real developer with a big pipeline of development assets to
support a yield co. Is that what you meant to say?
MR. ARMISTEAD: Is this a negotiation? [Laughter.] Good
lawyers put the question in a
way that comes close to answering it. I think that the investor
base that has been attracted to
the existing yield cos has put a
premium on strong sponsorship,
a strong pipeline that allows for
growth, stability and a track
record running the operations
side of the business. If those variables are there, then I think there
is more room in the market.

Maybe someone who cannot check off all these boxes will find
another group of investors that is looking for something
MR. MARTIN: Andy Redinger, is there much room in the market
for more yield cos?
MR. REDINGER: Absolutely. There is a lot of room. I think a yield
co is a real estate company. It is an opportunity to invest in an
asset class that looks a lot like real estate with characteristics
that are much better than what is in existing REITs today. There
is a huge volume of potential yield cos coming to market in 2015.
Look at the REIT market. REITs have been around for more than
25 years and have a current market capitalization of more than
$400 billion. I challenge anybody to compare REIT assets to yield
co assets, and I will tell you all day long that yield cos are a better
asset class.
MR. MARTIN: So you see a lot of pent-up demand for yield cos
in 2015. How many more do you foresee, and will the next round
of yield cos be roll ups of assets from third parties as opposed to
the Pattern or NRG Yield model?
MR. REDINGER: Hunter Armistead is absolutely right. We will
see a different type of yield co in 2015. The yield cos we have
seen to date have all had strong sponsors backing them. It will
be interesting to see whether the market differentiates between
sponsor-backed yield cos versus the two of us getting together,
going out and buying assets and saying we are a yield co.
MR. MARTIN: Can we do that?
MR. REDINGER: We absolutely can.
MR. MARTIN: So roll ups work.
MR. REDINGER: Well, I am not calling it a roll up. Otherwise,
you would have to call the entire REIT industry a roll up. Yield cos
are similar to what is already done in the REIT space.
MR. MARTIN: I did not hear a number of how many more yield
cos will come to market in 2015. Can you give us a number?
MR. REDINGER: It is more than a dozen.
MR. MARTIN: Carl Weatherley-White, do roll ups work?
MR. MARTIN: Isnt future growth less certain for a roll up? Yield
cos are like vacuum cleaners. With so many yield cos competing
for assets, eventually you run out of things to vacuum up.
MR. WEATHERLEY-WHITE: Thats a great question. I think the
emergence of more yield cos is not only possible, but really
required for this market to develop. Investors are looking for more
opportunities to participate in the space. Depending on how you
define yield co, there are five or six companies today. The
market capitalization of the existing yield / continued page 14

Canada. All of the projects were built in the last

five years. Sol-Wind focuses on middle-market
assets: solar ranging from 100 kilowatts to five
megawatts and wind between from one and 10
megawatts in size.

The company said it would put all the

projects under two corporate subsidiaries: one for

US projects and the other for projects in other
countries. It planned to raise $174 million from
the public by listing on the New York Stock
Exchange and $248.1 million from its sponsor, 40
North Investments, and use the money to buy the
initial portfolio. The sponsor planned to retain
56.6% of the ownership interests through a mix
of common and subordinated units. The sponsor
would also have incentive distribution rights
entitling the sponsor to as much as 50% of the
excess cash flow after distributions of at least
37.38 per unit have been made each quarter on
all the other units.

Sol-Wind said it has a pipeline of another

1,098.6 megawatts of solar and wind projects

that it has entered into memoranda of understanding or holds rights of first refusal to acquire
through the end of 2017. Some of the pipeline
projects are in Japan, Mexico, the United Kingdom
and Puerto Rico. The rest are on the US mainland.

The company planned to inject the money

raised into the corporate subsidiaries that own

the projects partly as equity and partly as debt.
This would allow the company to strip earnings
from the corporate subsidiaries as deductible
interest on the debt, thereby subjecting the
stripped earnings to only one level of tax at the
level of the MLP partners. The remaining earnings
would come up to the MLP as dividends. Sol-Wind
said it expects almost all of its income to be
dividends or interest. It said it does not expect the
corporate subsidiaries to have significant
taxable income for 15 or more years.

Interest in the MLP market could increase as

an alternative to yield cos. The six existing yield

cos have a combined market capitalization of $12
billion. There are 120 MLPs / continued page 15

FE B RUA RY 2015



Yield Cos
continued from page 13

cos is about $12 billion. The market capitalization of the existing

master limited partnerships is about $600 billion.
More than 50 times as much capital is looking for opportunities like yield cos than is invested in the existing yield cos.
The question is whether there are enough assets to support
that type of growth, and I think there are. Many new energy and
other infrastructure projects are being built worldwide.

Necessary Predicates
MR. MARTIN: Andy Redinger, what are the necessary predicates
before you can have a yield co? For example, how much asset
volume do you need to start?
MR. REDINGER: Two years ago, you needed at least $1 billion
in equity value. Today, $500 million is probably the minimum
with at least $30 million a year in distributable cash flow. Can
you do something smaller? Sure, but I do not think it will trade
as well. You will see all kinds of yield cos coming to market this
year. I think you need a development pipeline. You need to show
an ability to grow, and you need to show some geographic
MR. MARTIN: So the yield co must have at least $500 million
asset value. How much capital must it come to market hoping
to raise against that much asset value? At least $100 million?
MR. REDINGER: You usually see 30% to 40% of the company
sold in the initial public offering, so that would be $150 to $200
million as the initial capital raise. The objective is to take as little
public as possible out of the box, but enough to ensure good
execution. This will let the sponsor benefit from any upward
price appreciation on its remaining ownership percentage after
the IPO. You come to market as small as the market will allow
and leave a lot in the development pipeline to show the potential for growth.
MR. MARTIN: Hunter Armistead, you have been through the
process. Do those numbers sound right?
MR. ARMISTEAD: They are the right numbers for when Pattern
went to market. One of the real challenges today is asset valuations have stepped up. Delivering growth is not just a matter of
adding new assets, but it is also growing dividends per share.
Depending on the yield cos cost of capital, that could be hard to
do, given the sky-high asset valuations, unless the yield co has a
strong development pipeline from an affiliated sponsor.
MR. MARTIN: This is where I was trying to pin you down



F EB RUA RY 2015

before! So a yield co needs a sponsor with a healthy development

MR. ARMISTEAD: There are two different kinds of yield cos.
MR. MARTIN: Lets move to cash flow. Some assets put into
yield cos are subject to debt or tax equity. What percentage of
the operating cash flow should be available for distribution to
shareholders, or put differently, what percentage of it can be
used for debt service or be distributed to tax equity? 65%? Less?
MR. REDINGER: Roughly a third of the revenue should be available for distribution. However, the trend today is to de-lever the
assets going into yield cos or to have an amortization profile that
is better suited for a yield co, for example, by having less amortization early on and maybe more later or there may be no
MR. MARTIN: So you front load the cash available for
MR. REDINGER: Yes. Yield co investors tend to be more focused
on the short term. Yield cos tend to be valued based on next
years cash flows.
MR. MARTIN: Why would anyone be fooled by that? [Laughter.]
MR. WEATHERLEY-WHITE: It is important for management
teams and bankers involved to have a strong handle on the cash
flow projections. To miss a dividend and to fail to grow the dividend will lead to a failed company. Therefore, to value something
based on first-year cash flow that trails off is setting the company
up for a huge problem. The fancy vehicles, as Andy said, are
designed to produce steady cash flows, less leverage, tax equity
with less dramatic flips: those sort of things.
MR. MARTIN: Maybe one lesson for anyone doing tax equity
is not to give 99% of the cash to the tax equity investor, but to
work out a different sharing ratio, and not to have cash flow
sweeps to pay indemnities. What cash sharing ratio should a
sponsor aspire to if he wants to preserve the option to move a
project later into a yield co?
MR. WEATHERLEY-WHITE: Just try for a fixed sharing ratio that
leaves a significant amount of cash each year for the sponsor.
MR. MARTIN: I hope John Eber [head of tax equity investments
for JPMorgan Capital Corporation], who is sitting in front of me,
is listening to this.
MR. ARMISTEAD: John stuck me on his panel, so maybe this is
my opportunity. It is an unnatural state when the tax equity is
earning a higher return than the sponsors. [Laughter.]
MR. MARTIN: John asks, What wrong with that? [Laughter.]
MR. ARMISTEAD: The wind business has reached a stage of
maturity where performance is much more reliable. This has

allowed the cash sharing ratios in tax equity structures to move

today to a better split that makes projects more suitable for
yield cos.
MR. BURGALETA: You must send a message to your investors
that you will not fool around with cash flow, and you have to be
very careful about what you announce because you will have to
keep to that every quarter.
MR. MARTIN: So you must be careful about the dividend you
announce because you create an expectation.
How much should one expect to spend to put a yield co in
place, and how long does the process take?
MR. ARMISTEAD: This is an interesting thing. We have a banker
who loves every yield co.
MR. MARTIN: Andy Redinger, that is smack talk. Are you going
to let that go unanswered? [Laughter.]
MR. REDINGER: The question is how costly, how hard and what
does it mean when you get there?
MR. MARTIN: Give me some numbers.
MR. REDINGER: I dont like to share them because somehow
they will end up all going to you, Keith, as a lawyer . . . . [Laughter
and talking over each other.] Four to $5 million in costs and nine
months to a year to complete the offering.
MR. MARTIN: . . . which is not bad. Two data storage companies
that converted recently to REITs said it cost them as much as $145
to $155 million in conversion costs.
MR. ARMISTEAD: I dont think they included underwriter fees
in that. Actually, I am certain of that. [Laughter and talking over
each other.] Andy does it pro bono.

with a market capitalization of close to $600

billion. In 2013, MLPs raised $43 billion in initial
public offerings, almost 17% of the entire US
equity market. Almost 60% of MLPs are fewer
than five years old. As many as another 25 MLPs
are expected to come to market this year.

MLPs have expanded in recent years into

new asset classes such as container ships,

offshore oil services and wood pellets. At least
one paper company is rumored to have a ruling
request pending at the IRS to move part of its
operations under an MLP.

The IRS put a hold in 2014 on any further

rulings about qualification of entities as MLPs

while it sorts out a hamburger stand issue. A
third of MLP rulings in the year before the hold
involved companies that provide services in
connection with hydraulic fracturing of oil and
gas. The IRS has been concerned about rulings
creep as services become farther and farther
removed from actual oil or gas production. For
example, is owning hamburger stands at fracking
sites to feed workers closely enough related to oil
and gas production to qualify?

The IRS is expected to release the hold in the

not too distant future, Erik Corwin, IRS deputy

chief counsel (technical), said in early January.

In early February, President Obama called in

his budget message to Congress to repeal the

Cost of Capital

exemption from the corporate income tax for

MR. MARTIN: Yield cos pay low dividends on the order of 3%, 4%,
6% and yet most of the shares are held by institutional investors
who have other places they can put their money that earn returns
in the teens. The shareholders are looking for growth on top of
dividends. What is the true cost of capital to yield cos in the
current market?
MR. MCILHENNY: A rule of the thumb is that if you can project
15% dividend growth, then you can pay a current dividend yield
of 3%.
MR. MARTIN: To what does that translate as a cost of capital?
MR. MCILHENNY: You can figure it out mathematically. The
perception of growth is key to value. That perception can lower
the cost of capital for the initial public offering. A high growth
rate can lower the cost of capital for drop-down assets. Higher
than expected growth can increase the / continued page 16

publicly-traded partnerships with qualifying

income and gains from activities relating to fossil
fuels. He proposed a January 1, 2021 effective
date for the change.
Dave Camp (R-Michigan), who led the House
tax-writing committee, but retired from
Congress at the end of 2014, proposed in a
comprehensive corporate tax reform bill last
year to tax master limited partnerships,
except for minerals and natural resources
businesses, like corporations, effective after
2016. The Camp tax reform bill may serve as
a starting point for any corporate tax reform
discussions later this year.
/ continued page 17

FE B RUA RY 2015



Yield Cos
continued from page 15

value of the sponsors incentive distribution rights.

Growth is key, and that is a different metric for financing
through a yield co than the project finance market traditionally
looks at things. Project financiers look at the long-term cash flow
and tax benefits and come up with an internal rate of return that
they need on their investment. In contrast, a yield co investor
looks for a current dividend yield, some years of comfort that the
yield will be maintained, and a dream that it will be there for a
long, long time. The quality of the yield co assets affects whether
the dream will come true.

Discount rates in some yield co bids

are mid-6% to 7%.

The bottom line is it is hard to say what the cost of capital is

for a yield co. The cost is affected by a number of factors.
MR. MARTIN: Is it as simple as to add a 3% dividend yield to a
15% growth expectation, which equals 18%?
MR. MARTIN: So you solve for the internal rate of return that
sets the present value of the dividend stream, starting at 3% and
growing at 15% a year, equal to your investment.
Hunter Armistead, is a yield co a form of financing for a development company?
MR. ARMISTEAD: It is an interesting question that we faced
when we were evaluating the right vehicle. Keith told us to keep
the answers short and controversial. That was his only guidance,
so I need to shorten it up. [Laughter.]



F EB RUA RY 2015

MR. MARTIN: We also need the controversial.

MR. ARMISTEAD: I am trying to avoid that. It is cost-effective
capital. The cost is not stratospheric compared to what we would
be looking for from a pension fund. The numbers that we saw
when we valued our assets in anticipation of forming a yield co
were not that different than when we ultimately did our trade
on the public exchange. The reason for going public had nothing
to do with monetization. It was funding our growth. If you are
just buying current short-term dividend growth or capital yield,
with a low IRR, then that will turn on you in the future. You have
to keep an eye on both.
MR. MARTIN: Carl Weatherley-White, I was looking at the
dividend yields for three yield cos. They are 4.87% for Pattern,
3.6% for TerraForm, 2.91% for NRG Yield. What accounts for the
differences in dividend yields? Is
it just growth expectations?
market is evolving. There is a differentiation among business
models. Investors assign different values to different models.
This is a natural evolution. As
more companies come to the
market, there will be more differentiation and ways for sponsors to play it.
MR . M ARTIN: David
McIlhenny, you are nodding.
MR. MCILHENNY: I was just
going to ask Carl a question. Why is NextEras yield so low compared to Patterns yield?
MR. WEATHERLEY-WHITE: NextEra has an enormous inventory
of assets that it owns and operates, so investors can be more
confident about the potential for growth. Pattern has an outstanding development team and a proven track record, and it
will grow as well. You are seeing differentiation in yield, which I
think is a function of growth expectation.

MR. MARTIN: Fair enough. Lets focus on how yield cos grow. They
distribute almost all their operating net cash flow. So in order to
have cash to make acquisitions, they must either borrow or raise
more equity, thereby diluting the existing shareholders. Why isnt

this a zero sum game? How does one get growth out of such a
process? Alex Burgaleta.
MR. BURGALETA: The sponsor must drop down or contribute
assets in an accretive way for the existing shareholders.
MR. MARTIN: What does it mean to contribute assets in an
accretive way?
MR. BURGALETA: When you dilute the existing shareholders
by issuing new shares, the amount of cash that the shareholders
will be distributed per share is higher than before.
MR. MARTIN: Are there any other ways of expressing this?
MR. WEATHERLEY-WHITE: It is the same model that has
existed in the REIT and MLP sectors for many years. Alex said it
well. There must be a difference between the value at which
assets are brought into the yield co and the cost of capital.
MR. MARTIN: You basically raise money at a higher price-toearnings ratio and reinvest at a lower one. What are current
spreads in the yield co market? Are they narrowing or widening?
Andy Redinger.
MR. REDINGER: The spreads are definitely narrowing as the
demand for assets heats up. We are seeing other players coming
into the market and competing with yield cos for assets. Pension
funds and infrastructure funds are two examples of other
sources of capital that have become more aggressive recently.
MR. MARTIN: Spreads are tightening. Does that suggest a
shortage of product? Hunter Armistead.
MR. ARMISTEAD: I think you are getting to one of the core
challenges if your growth model is acquisitions. As the spread
narrows, it becomes harder to do more acquisitions on an economic basis. If you cant do any more deals, then you cant grow.
That is where it helps to have a deep development pipeline to
have a captive group of assets that provides that accretive
growth as opposed to having to rely on the spread.
MR. MARTIN: Hunter Armistead, your company has said that
the market has become too frothy. Asset values are inflated
you are wincing as I say this so you will focus on your own
pipeline probably to the exclusion of buying assets from third
MR. ARMISTEAD: We continue to evaluate third-party acquisitions, but at the core, we maintain a deep, strong development
pipeline that can feed the growth. To the extent we can augment
that with acquisitions from third parties, we will do it, but we
dont feel like we have to do it.
MR. REDINGER: These ebbs and flows are natural in the marketplace. The tightening will force yield cos to look other places
/ continued page 18
for assets: international, residential

MORE CREBS may be issued.

CREBs are a form of tax-exempt bond on

which the lenders receive tax credits from the

federal government in place of interest. The tax
credits must be reported as income. The acronym
stands for clean renewable energy bond.

The bonds can be used to finance wind, solar,

geothermal, biomass, landfill gas, incremental

hydroelectric and ocean energy projects that are
owned by municipal utilities, government
agencies, Indian tribes, electric cooperatives and
US possessions. Anyone proposing to issue CREBs
must apply to the IRS for an allocation. Congress
authorized up to $2.4 billion in such bonds.

The IRS announced in early February that it

will allocate approximately $1.4 billion in remaining bond authority. Anyone given an allocation
must issue the bonds within three years or else
the authority reverts to the IRS and will be
re-awarded to someone else.

Public power providers (municipal utilities)

must apply by June 3, 2015 and will share up to

$516,565,691.35 in remaining bond authority.
The bond authority for public power providers
will be allocated using a pro rata method. If the
total amount applied for exceeds the amount
available, then the volume cap will be split pro
rata among all the eligible projects. Thus, for
example, if the $516 million is two times oversubscribed, then each public power provider will
receive authority to issue bonds covering half its
project cost.

Governmental bodies and electric coopera-

tives must apply by March 5, 2015. There is

$597,134,963.60 in volume cap remaining for
governmental bodies and $280,778,469 for
electric cooperatives. Volume cap for these two
categories will be handed out on a first-come,
first-served basis. However, no applicant may be
awarded more than $40 million or, if greater,
20% of the total amount available for award in
its category (governmental bodies or electric
/ continued page 19

FE B RUA RY 2015



Yield Cos

Discount Rates

continued from page 17

solar. What ebbs today will flow again later. Smart companies
are already thinking about this. You will see a broader mix of
assets put into yield cos.
MR. WEATHERLEY-WHITE: Thats a great point. There is a
natural evolution. I am also interested in what Hunter Armistead
said because he is a developer. I see this as a search for a lower
cost of capital that can then be applied to the ownership of
assets, which then results in a more competitive electricity price.
When we talk to developers about the opportunities of yield cos,
they are working backwards from what electricity price works.
MR. ARMISTEAD: Hit me with the question again.
MR. WEATHERLEY-WHITE: When you think about what returns
are necessary to support a power contract bid, you think about
your cost of capital and do you consider yield co capital as giving
you a competitive advantage?
MR. MARTIN: You are setting him up, because you are asking
Hunter to admit that his yield co is a form of a financing.
MR. ARMISTEAD: Thank you! [Laughter.]
MR. MARTIN: Im a lawyer.
MR. ARMISTEAD: I think the answer to your question is yes.
We were originally funded by Riverstone when Pattern was first
formed. Thats a private equity fund. The returns we were searching for, which included some yield compression, were materially
higher than what we see would deliver very solid growth to our
public vehicle. So, yes, the yield co allows us to be more aggressive
when bidding for power contracts.
MR. MARTIN: Alex Burgaleta, do you want to add to that?
MR. BURGALETA: We have to look at the cost of capital of yield
cos as something that is not as steady. The cost depends on the
rate at which the yield co will acquire assets and the market
prices at which it will do so. You cannot look at the yield co on a
stand-alone basis; it is a more dynamic process.
MR. MARTIN: Your cost of capital may be harder to predict.
MR. BURGALETA: Yes. A yield co has a window in time when it
may be most efficient and aggressive. But you have to be careful
because you have to deliver the growth, and then we will discuss
how you do so. Do you already have the assets? Do you develop
the assets? Do you buy the assets? How much value are you
bringing to the shareholders by contributing those assets? These
different paths to growth are not equal.



F EB RUA RY 2015

MR. MARTIN: There are many strategics that felt, when yield cos
first appeared, that yield cos would have the lowest cost of
capital and would win all the auctions for assets. Has that in fact
MR. ARMISTEAD: As a loser of a bunch of options, no. There
have been some big transactions that were transformative for a
couple of the other companies that pay dividends like us; you can
see I am moving away from the term yield co. In our experience,
the most aggressive bidders are buyers who want to form a new
yield co and are trying to get to a critical mass of assets. We have
seen bidders pay materially more than we thought justified. We
feel like we have a good growth engine and do not have to stretch
to grow.
MR. MARTIN: What discount rate do you think yield cos are
using to win assets in the current market?
MR. REDINGER: I think 9% to 10% levered would get you right
in the middle of the bell curve.
MR. MARTIN: What about unlevered?
MR. REDINGER: Three hundred basis points below that, so
somewhere mid-6% to 7% unlevered may win you the deal, or at
least get you into the second round.
MR. MARTIN: I would have thought 8% was enough to get
you in.
MR. REDINGER: That is the tightening that we talked about
MR. ARMISTEAD: One of my favorite things is that it is not just
about the return, it is also about the assumptions. What will it
really cost to operate an asset? How well will it perform? Maybe
you will not hit the flip points on schedule in the tax equity
partnership and that changes the entire game and the internal
rate of return. You may think you bought at 9% but you did not
get it at 9%.
MR. MARTIN: I didnt follow that.
MR. ARMISTEAD: The banker for the seller sends you a pro
forma that was prepared by the sponsor. If you bid based on the
pro forma numbers, sure you bid at 9%, but when you actually
realize that production is different, the operating costs are higher,
and you have to add more workers at the local site, things get a
lot more tight.
MR. BURGALETA: You also have to consider the profile of the
cash flow as it changes dramatically from one market to the next.
We are looking at projects in Brazil, South Africa and other places
with high inflation rates, where cash flows are growing by 6% or

7% a year. Compare that with markets like the US and Canada

with really flat cash flows or cash flows that decrease over time.
MR. MARTIN: Yield cos are usually built around a renewables
base, but does it work to have solely renewables? Dont you need
some tax capacity in the yield co itself? Andy Redinger, you are
shaking your head no.
MR. REDINGER: No, because yield cos are vehicles that need
tax credits and depreciation to shelter the income going forward.
It is true that the yield co is not using the tax benefits efficiently,
but the ability to roll the tax benefits forward and use them to
shelter future income is what gives yield cos access to cheaper
equity capital.
MR. MARTIN: If the yield co has a tax base, doesnt it have a
valuable asset that can be used to earn an additional return in
the renewable energy market?
MR. REDINGER: That is another story entirely. One of the things
we are always tracking closely is what is our carryforward. Yield
cos like to be able to project enough tax shelter far enough into
the future so that they do not have to worry about taxes reducing
the cash available for distribution.
MR. MARTIN: You like to be able to say to the investors that
you expect to operate tax-free for nine or 10 years based on the
existing asset portfolio.
MR. REDINGER: Correct. At the same time, we are trying to
figure out how to make more efficient use of tax equity.

NETWORK UPGRADE payments had to be

reported as income by utilities, the IRS said.

to supply local residents. Transmission was a

problem. It entered into negotiations with a
private transmission company to build a transmission line that would bring the additional
electricity. The line was a bridge between two
regional grids. The transmission company will
own the new line. The municipal utility
subscribed for a percentage of the transmission
capacity on the new line.

MR. MARTIN: David McIlhenny, what are some pros and cons
that a company that is already in business thinks about when
deciding whether to form a yield co?
MR. MCILHENNY: On the pro side, the company should be able
to reduce its cost of capital. A yield co is a form of financing future
cash flows. It is also a way for a developer to retain long-term
exposure to the value of the project rather than just selling it off,
or doing some other type of financing where the upside is given
to some other party. The long-term value is captured through
retaining incentive distribution rights.
The cons are the yield co will divert management attention. It
will make you think more like a finance company and less like a
solar company or developer.
MR. MARTIN: Alex Burgaleta, do you want to add to that?
MR. BURGALETA: Yield cos are good examples of sensible risk
and return allocation. Forming a yield co forces you to change
the way you handle your business because / continued page 20

The administrator of one of the two regional

grids required three neighboring utilities to

upgrade their transmission systems so that the
additional power flows over the regional grid on
account of the new transmission line will not be
impeded by congestion or bottlenecks on neighboring systems.

The transmission company building the new

line agreed to reimburse the three neighboring

utilities for the cost of the network upgrades to
their systems. The municipal utility agreed, in
turn, to reimburse the full cost even though it
was subscribing for only a portion of the new
transmission capacity.

Sensible to Form?

A municipal utility needed more electricity

The utilities asked the IRS whether they have

to report the cost reimbursements as income. The

IRS said yes in two adverse rulings the agency
released in December and January. The rulings
are Private Letter Rulings 201451007 and

It is rare to see an adverse ruling. Companies

requesting rulings usually withdraw the requests

if they are told the IRS will not rule favorably.

The IRS said the utilities could avoid report-

ing the cost reimbursements as income only if

they can show the company reimbursing them is
acting solely for the public benefit and not for any
private benefit it might receive.

The IRS is walking back from its past

positions in this area. The agency said in three

notices and one revenue procedure from 1988
through 2005 that payments a utility receives
from an independent

FE B RUA RY 2015

/ continued page 21



Yield Cos

MR. ARMISTEAD: When you invest in a developer, you can lose

everything or the investment can pay big dividends. A yield co
continued from page 19
should be a less risky investment.
the business is different. We have development companies that
MR. MARTIN: What happens when the market shifts and
are also listed and are feeding yield cos. That changes how we
developers find a cheaper way to raise capital or they find other
think about the development business. If yield cos do a good job
buyers willing to pay more for assets? What happens to the yield
maintaining asset quality and see their dividend payments grow,
co at that point? Andy Redinger.
then we will see even more yield cos as they offer something of
MR. REDINGER: They all get bought out or merged.
value: access to cheaper capital.
MR. MARTIN: Hunter Armistead, you were one of the early
MR. MARTIN: David McIlhenny, some people say that yield cos
adopters of yield cos. What issues have come up in the first year
do not work for the solar rooftop business because there is so
and half of operation that you perhaps did not foresee?
little development risk. You are not getting much of a pop in
MR. ARMISTEAD: We had a lot to learn. We have successfully
moving to a yield co. Make sense?
managed and developed assets, but we have never managed a
MR. MCILHENNY: Residential assets have not been part of yield
public company. Dealing with all of the reporting requirements
cos so far because yield cos are evolving, and they started off
and setting up the infrastructure so you can close your financials;
with the best assets, which are big utility-scale projects with
if you are a private company and are a few days late on your
long-term power contracts with creditworthy offtakers and little
financials, you call Riverstone and say, We are a few days late.
technology risk. As the yield co market has evolved, every new
There is no leeway with a yield co.
yield co has done something different: incentive distribution
We went into the yield co with our eyes open and we assumed
rights, distributed generation, projects that actually are not in
it was going to be tough, but it was tougher. Then there is the
service but count as IPO projects, foreign assets. Residential solar
pressure to keep growing at the same time.
is an asset class that can be part of yield co, but it just has not
Another thing is Andy Redinger said it is $5 to $7 million dollars
been done yet.
to stand up a yield co. It was more for us. Maybe we were not
efficient at it the first time, but it is expensive to do. The infraOther Issues
structure to support it is significant. If you start going into new
MR. MARTIN: As an investor, are you better off investing in the
jurisdictions, you have a lot more rules to master, like the need
development company or in the yield co?
to close the books at the right time. It sounds really cool to do a
MR. BURGALETA: What kind of car do you have? Do you have
deal in Chile, but you end up creating more stress at every turn
a Prius or a Corvette? [Laughter.]
with additional regulatory requirements. We have had to hire
MR. MARTIN: Im the one asking the questions here! You dont
more people than we thought we were going to have to hire.
think it matters?
MR. MARTIN: That is a good bridge to my next question. What
complications are created when
the yield cos run out of assets to
vacuum up in the US and start
looking more widely overseas?
You mentioned one. Does anything else come to mind? Andy
Sol-Wind brought a renewable energy MLP to market,
MR. REDINGER: Currency risk.
Obviously, there are also repabut then postponed the offering.
triation risk and the tax consequences of bringing the money
back into the US.



F EB RUA RY 2015

MR. MARTIN: Alex Burgaleta, you deal with this all the time as
your company operates in multiple countries.
MR. BURGALETA: I was going to say, if you are worried about
Chile, wait for Brazil. [Laughter.]
MR. MARTIN: Energy Capital Partners packaged a group of
gas-fired power plants and put them in a public vehicle. Compare
that play to a yield co.
MR. MCILHENNY: Fossil fuel plants have fewer tax benefits,
so the public company will be paying taxes, and there will be less
cash for dividends.
MR. MARTIN: Where do you see the growth in that sort of
MR. MCILHENNY: Buying up old assets, I would think.
MR. WEATHERLEY-WHITE: But will those be contracted? That
is a really interesting point because not all assets meet what you
are trying to do here. Five- and 10-year contracts are tricky.
MR. REDINGER: The boundaries of yield cos are expanding so,
as time goes by, unless there is a misstep, yield cos will push the
bounds with shorter PPA terms, uncreditworthy offtakers and
merchant opportunities. When there is a problem, things will
stop. Until there is a problem, the market will keep pushing the
MR. WEATHERLEY-WHITE: Look at the acquisition of First Wind
by TerraForm. There was a lot of discussion about the shorter
PPAs, I think 10 years on average, than what we were accustomed to seeing until then in yield cos, and TerraForm talked
about re-contracting and the value of that. We are already
starting to see movement in the market.
MR. MARTIN: A lot of intellectual capital will be required
going forward and perhaps higher returns as riskier assets land
in yield cos.
MR. BURGALETA: There is a huge opportunity for yield cos
overseas. In many overseas markets, the demand for electricity
is actually growing, unlike the United States. The combination of
growing demand and a way to reduce the cost of capital will
prove very enticing.

generator who is not a customer of the utility to

reimburse for network upgrades do not have to
be reported as income. The IRS issued four private
letter rulings from 1991 through 1995 that
confirmed the same policy applies to cost
reimbursements a utility receives from another
utility for network upgrades when a new transmission line is installed.

The current position of the IRS branch

handling these issues is that it will not extend

the logic to other fact patterns besides those
addressed in the existing notices.
The IRS and Treasury lawyers who worked on
the first two notices in 1988 and 1990 had no
difficulty using the logic behind them to
analyze other fact patterns that were not
known when the original notices were
written. The reason there are three notices
and one revenue procedure is the IRS has
periodically updated its guidance to address
new fact patterns as the power industry has
evolved over time.
SOLAR TAX CREDITS can be claimed on special

membranes put on roofs underneath solar

panels, but only on the incremental cost above
what replacing the roof would cost, the IRS said.

The IRS made the statement in a private

letter ruling that it made public in December. The

ruling is Private Letter Ruling 201450013.

A company asked the IRS whether it could

claim an investment tax credit on a solar commercial rooftop system that it purchased. The system
uses bi-facial solar panels that absorb sunlight
on both sides of the panels. A special membrane
is put on the roof to reflect sunlight to the
backside of the panels. The panels are up to 40%
more efficient than regular panels. The
membrane covers 96% of the roof.
The IRS confirmed the membrane is considered part of the solar system, but said the
company had to back out the cost of putting
a new roof on the building without the reflective feature.
/ continued page 23

FE B RUA RY 2015



Egypts Feed-In Tariff

Program: Ready, Set
by Richard Keenan and Marc Norman, in Dubai, and Ahmed El Sharkawy,
Mohamed Nabil and Ahmad Farghal, with the Sharkawy & Sarhan law firm
in Cairo

Egypt recently released a shortlist of 110 qualified applicants for

solar photovoltaic and wind projects for the first regulatory
period of its new feed-in tariff scheme.
The first regulatory period runs from 2015 to 2017. During this
time, the Egyptian government aims to procure 4,300 megawatts
of renewable energy capacity, including 2,000 megawatts of
medium-to-large-scale solar photovoltaic facilities and 2,000
megawatts of wind facilities.
The 110 qualified applications include 13 small-to-mediumscale solar photovoltaic facilities (i.e., up to 20 megawatts), 69
large-scale solar photovoltaic facilities (i.e., from 20 megawatts
to 50 megawatts) and 28 wind facilities ranging from 20 megawatts to 50 megawatts.
Although certain known market participants are likely dissimulated behind special-purpose vehicles, many of the usual
suspects are included in the shortlist.
A number of companies bid for more than one renewable
energy source or solar photovoltaic facility size. Some renewable
energy developers are also rumored to be negotiating independent deals directly with the government most probably for
larger-scale projects given the 50-megawatt cap on facilities
procured under the feed-in tariff program.
The aggregate capacity of the large-scale solar projects that
the 69 qualified bidding consortia have applied to develop under
the feed-in tariff scheme exceeds the governments target of

2,000 megawatts by around 50%. This means that a certain

number of qualified bidding consortia will miss out, at least for
the first regulatory period.
The aggregate capacity of the wind projects that the 28 qualified bidding consortia have applied to develop falls below the
governments target of 2,000 megawatts. This means that a
further request for qualification for wind projects will be issued
by the government during the first regulatory period.
The priority for all qualified bidders and particularly for solar
project bidders must now be to position themselves to join
the top of the queue for site allocation and thereby project
award. The extent to which project award will ultimately come
down to speed of company incorporation and grid connection
downpayment remains to be seen; other technical and project
viability criteria will surely play a role. However, one thing that
has become very clear is that it is in the interest of all qualified
bidders to organize themselves as quickly as possible to make
sure that they are at the top of the queue and do not end up on
a waiting list.
We understand that the government will provide 36 plots of
land to qualified bidders for large-scale solar projects on a firstcome, first-served basis.
Qualified bidders who are not allocated one of these sites
will also be free to source their own sites. However, sites provided by the government have the advantage of being fully
permitted. Developers who source their own land will have to
provide to the government evidence of ownership or satisfactory usufruct rights.
How do qualified bidders position themselves to be eligible
for a government-allocated site?
There are two requirements that must be satisfied as soon
as possible. First, the applicant must establish a special-purpose
vehicle for the project. Second, the applicant must make a
downpayment to cover grid connection costs. In early February, qualified
bidders were officially notified of the
downpayment amount.

Egypt wants 4,300 megawatts of new wind

and solar capacity by 2017.



F EB RUA RY 2015

Establishment of SPE
Qualified bidders should incorporate an
Egyptian company under the investment law number 8 of 1997. Qualified
bidders may choose between incorporating a limited liability company or a
joint stock company.

Incorporation in Egypt takes one week from the date of

completion of all the required documents. It is very difficult to
transfer an LLC to a joint stock company.
It is not a practical option to acquire an existing shelf company.
Shelf companies are not known under Egyptian law. The only
way to acquire a joint stock company is through a share transfer.
Share transfers require a lot of notarized and consularized declarations and documents in addition to appointing a stock broker
to effect the transfer on the Egyptian Stock Exchange.
Joint stock companies offer some advantages that are not
available in LLCs, such as the ability to list the company on the
stock exchange and to offer shares, bonds and other securities
to the public. There is a minimum capital requirement for joint
stock companies, but only 10% of the share capital must be paid
up upon incorporation and another 15% must be paid up within
three months and the remainder within five years after incorporation. Joint stock companies are more appealing to banks when
financing a project because it is possible for banks to obtain
pledges over the shares as security; the enforceability of pledges
over partnership interests in LLCs is unclear under Egyptian law.
More details about the differences between LLCs and joint
stock companies are in a sidebar with this article.

A MINING COMPANY leased rather than sold its

interest in a mine to a third party, the IRS decided

on audit.

The decision affects how much and when

income must be reported from the transaction.

It is interesting because it suggests a tax planning
tool that might be used to avoid triggering a sale.

The mining company owned an interest in

the mine in a joint venture with other companies,

but the owners elected for US tax purposes to
treat each owner as if it owned an undivided
interest in the mine directly. Each reported its
share of revenue and costs directly.

The mining company transferred its

fractional interest in the mine to a third party. It

was paid cash up front for the interest and was
promised another lump-sum bonus payment
in the future if the mineral reserves increase by
at least X tons. It will also receive ongoing
production royalties that are a percentage of
revenue from sales of output, but these payments
do not start until output sales from the mine pass
a threshold.

Grid Connection Downpayment

Each developer is responsible for its share of grid interconnection

costs. We understand from government briefings and recent
feedback from developers that interconnection costs will be split
among developers sharing the same substation.
Each qualified bidder will be required to make a grid connection downpayment. In early February, qualified bidders were
officially notified of the downpayment amount.
Government sources have confirmed that this downpayment
can only be made through the provision of a check or cash.

The IRS addressed what label to put on the

transaction in a technical advice memorandum, or a ruling by the national office to settle

a dispute between a taxpayer and an IRS agent.
The ruling is Technical Advice Memorandum
201448002. The IRS made it public in December.

The IRS said whether the transfer of an inter-

est in a mine is a lease or a sale turns on what

sort of interest, if any, the seller retains. If the
owner retains no interest, then the transfer is a
sale. It is also a sale if the owner transfers a

PPA and Government Guarantee

non-operating interest and retains an operating

We understand from government briefings that draft project

documentation (including the power purchase agreement and
usufruct agreement) have been prepared. Developers and financiers are expecting these documents to be broadly consistent
with Egypts IPP template.
Egypts IPP template originates from the Sidi Krir IPP
(a 682.5-megawatt gas-fired steam power plant initially developed by InterGen that went into commercial operation in late
2001), the Port Said IPP (a 683-megawatt gas-fired power plant
initially developed by EDF that commenced / continued page 24

interest. For example, the owner retains the right

for a period of time or for a fixed tonnage to
remove minerals, but transfers everything else.
It is a lease if the owner retains an economic
interest. An economic interest is a right to
ongoing payments that are tied to production.

The IRS pointed to a 1972 US Tax Court

decision in a case called Ridley v. Commissioner

where a mine owner received an upfront
payment at closing and no / continued page 25

FE B RUA RY 2015



continued from page 23

commercial operation in 2003) and the Gulf of Suez IPP (a

683-megawatt gas-fired power plant initially developed by EDF
that reached commercial operation in 2003). This precedent has
since been further developed in connection with the Dairut IPP
and other projects such as the Gulf of Suez wind IPP.
The draft project documentation is currently being reviewed
from a bankability perspective by leading financial institutions
based on discussions with the New and Renewable Energy
Authority about the required terms. The project documentation
is expected to be amended to address any bankability concerns
raised by the relevant financial institutions and then issued to
successful bidders. Given the programs ambitious timetable, the
New and Renewable Energy Authority and Egyptian Electricity
and Transmission Company will have to provide developers with
a bankable form of power purchase agreement as soon as possible. As with any new IPP program, the development of standard-form templates can be a time-consuming process. We
expect that developers may have some reservations about
making upfront financial commitments without any visibility on
the form of PPA and proposed risk allocation.
The power purchase agreement tariff for large-scale projects
will be denominated in US dollars, but be payable in Egyptian
pounds. This is significant given that the Egyptian pound has not
been pegged to the US dollar since 2003. Fifteen percent of each
invoice amount will be converted at a fixed rate of 7.15 pounds
to dollars, and the remaining 85% will be converted at the prevailing rate. This means that the Egyptian government will more or

It is offering feed-in tariffs of 9.57 to

14.34 a KWh to attract developers.



F EB RUA RY 2015

less assume exchange risk. A key question for financiers of these

projects will be the extent to which the government will also
assume the risk that that Egyptian pounds can actually be converted to US dollars. Depending on the extent to which the
Egyptian government assumes convertibility risk, the preferred
creditor status of multilaterals in the financings of these projects
could prove to be critical.
Projects with a capacity above 500 kilowatts will benefit from
a government guarantee issued by the Ministry of Finance.
The extent to which an equity sponsor may participate in
multiple consortia is unclear. Government sources previously
indicated that an equity sponsor could participate in multiple
consortia, so long as it acts as a lead developer in no more than
one consortium. However, we understand that the government
may be reassessing this position.

The Feed-in Tariff Program

Last year saw Egypt launch an ambitious program to procure
12,000 megawatts of renewable energy capacity by 2020, the
largest renewable energy target in the Middle East and North
Africa region, after Saudi Arabia.
Any seasoned Middle Eastern renewable energy stakeholder
would be forgiven for treating target announcements with some
skepticism. However, recent developments suggest there is cause
for excitement.
On October 20, 2014, the Egyptian government issued a
request for qualification to participate in the initial procurement
round of its freshly-issued feed-in tariff program for renewable
energy. The deadline to submit qualification requests was
November 26, 2014. The Egyptian Electricity Transmission
Company, Egypts renewable energy
procurement arm, is reported to have
received 177 submissions. In the first
week of January 2015, Egypt surprised
market participants by releasing its
shortlist of 110 qualified applicants.
Since the release of the shortlist, the
Egyptian government has made it
abundantly clear to all stakeholders that
it wants to move fast with the roll out
of its feed-in tariff program.
For many years, Egypt has faced a
major challenge in providing enough
electricity to its citizens. Power blackouts, a daily occurrence for many

Egyptians, stand out as one of the most explosive socio-political

issues in the Arab worlds most populous country; they were a
key factor in deepening discontent with President Mohamed
Morsi, who faced mass protests before Abdel Fattah al-Sisi, then
army chief, ousted him in 2013.
In early September 2014, the country experienced one of its
most severe blackouts in decades. The outages knocked TV stations off the air and halted parts of the Cairo subway, a major
embarrassment for a government that sought to provide stability
after protracted turmoil. As officials struggled to address the
public outcry, President Abdel Fattah al-Sisi addressed the
country in a candid television address saying that power blackouts were the result of years of underinvestment. Tackling
blackouts stands as a key government priority; however, there is
no immediate solution, he said. The President said the country
needs to add 12,000 megawatts to its grid over the next five
years at a capital cost of around US$12 billion.
Beyond the desperate need to increase generating capacity,
the country also faces a challenge to diversify its energy sources.
Oil and natural gas currently contribute 95% of the total
energy resources needed to generate electricity in Egypt.
However, according to the Egyptian energy strategy for 2030
together with its update until 2035, Egypt is expected to become
a net importer of oil and natural gas between 2030 and 2040.
As the cash-strapped country strives to meet other pressing
challenges such as water treatment and education needs, reducing dependence on oil and natural gas via energy-source diversification is viewed as critical.
Egyptian authorities see the procurement of solar photovoltaic
and wind facilities as an effective way to deploy additional power
generation capacity rapidly conventional facilities take considerably more time to bring on line and to reach their diversification goal.
Egypts feed-in tariff program was approved by the Cabinet
of Ministers on September 17, 2014, weeks after the major
The deployment of the program is spread out in a series of
regulatory periods. The first regulatory period runs from 2015
to 2017.
During the first regulatory period, Egypt aims to procure 4,300
megawatts of solar photovoltaic and wind capacity. (The explicit
references to photovoltaic technology imply that solar thermal
technologies are currently excluded from the feed-in tariff
program.) On the solar side, the plan is to procure 300 megawatts
/ continued page 27
of small-scale facilities (i.e., below

further payments until about 42% of the ore

reserves had been extracted. Thereafter, the mine
owner was paid a royalty on output. The Tax
Court said no sale occurred.
The transfer in this case was a lease, the IRS
said. The possible bonus payment was not an
economic interest because it was not tied
to the mine output, but the production
royalty is an economic interest.
SUCCESSOR LIABILITY can be a problem in

acquisitions, but not in this case.

The US Department of Justice told a US

consumer goods company in November that it

would not be prosecuted for bribes that another
consumer goods company it is acquiring paid to
foreign government officials should it close on
the acquisition.

The US Foreign Corrupt Practices Act makes

it a crime for a US company or US person to give

anything of value to an official of a foreign
government, international organization or
foreign political party in an effort to win or retain
business or secure an improper advantage.
Foreign companies raising funds in US capital
markets can also be prosecuted.

A US company is acquiring a foreign

consumer goods company in a foreign country

from a foreign seller. The US company did extensive diligence. Among other things, it had its
accounting firm review around 1,300 transactions with a value of $12.9 million. The accounting firm identified $100,000 in payments that
raised questions. Most of the payments were to
foreign government officials to obtain permits
and licenses. There were also some gifts and cash
donations to government officials, and there
were significant problems with how the target
company recorded these payments. Expenses
were inaccurately identified on the target companys books.

The American company revealed what it

had found to the US Department of Justice and

asked for an assurance that the US government
would not bring criminal charges or impose
/ continued page 27

FE B RUA RY 2015



Comparing Egyptian Limited Liability Companies to Joint Stock Companies

Joint Stock Company


Minimum required capital

EGP 250,000 (approximately US$ 34,000)

No minimum capital

Timing of capital

10% of the issued capital must be paid upon incorpo- Must be fully paid upon incorporation
ration. Another 15% must be paid within three months
after incorporation.
The rest of the issued capital is paid within five years
after incorporation.
The issued capital of the company can be denominated in a foreign currency. However, bidders in the
feed-in tariff program must pay the entire issued
capital upon incorporation.


The capital is divided into equal shares. The liability of The capital is divided into equal portions. The
each shareholder is limited to its shares.
liability of each partner is limited to its portion.

Minimum number of owners

A minimum of three shareholders at all times


A minimum of three managers. There is no nationality A minimum of one manager. At least one of the
managers must be Egyptian.

Transfers of shares

Founding shares and shares issued for contributions

in kind may not be transferred before publication of
the companys financial statements for the first two
full fiscal years without prior consent of the regulator

Lock-in periods for feed-in

tariff SPEs

The majority shareholder of the SPE cannot transfer more than 70% of its shares before commercial
operation without obtaining the approval of the Egyptian Electric Utility and Consumer Protection
Regulatory Agency.

Object of SPE

The object of the SPV must include generation and sale of electricity from new and renewable sources
and construction, management, operation and maintenance of electricity generation plants.

Changing the type of the SPE



The shares can be listed on the stock exchange after LLC interests cannot be listed on the stock
fulfilling certain requirements.

A minimum of two partners and a maximum of

50 partners.

Partners wishing to transfer their interests to

third parties must first offer them to existing
partners, who have a pre-emption period of one
month within which to purchase the interests
on a pro rata basis. The pre-emption right may
be waived by the shareholders before the end of
In addition, the shares cannot be transferred until at the one-month pre-emption period.
least 25% of the companys issued capital has been

It is very difficult to convert an LLC into a joint

stock company.

A joint stock company can issue securities by way of An LLC cannot issue securities by way of public
public offering.


The pledge of shares and enforcement of the pledge Usually when a pledge is obtained by lenders, it
are regulated by Egyptian law. This makes joint stock is coupled with an obligation to convert the
company into a joint stock company and reincompanies more appealing in terms of bankability.
state the pledge over the shares after
LLC interests cannot be in the form of transferrable conversion.
securities, and an LLC cannot issue any kind of securities. Accordingly, lenders cannot safely have a pledge
over LLC interests.


F EB RUA RY 2015


criminal penalties against the company after

the acquisition.

continued from page 25

500 kilowatts) and 2,000 megawatts of medium-scale facilities

(i.e., between 500 kilowatts and 20 megawatts) and large-scale
facilities (i.e., between 20 megawatts and 50 megawatts). The
wind target is 2,000 megawatts with project sizes ranging from
20 megawatts to 50 megawatts.
The initial plan was to issue a request for qualification every
three months during each regulatory period, allowing one month
for clarification requests, another for qualification submissions
and another for the issuance of results. However, based on our
understanding that the solar photovoltaic track is 50% oversubscribed, there should not be any further requests for qualification
in the first regulatory period. We expect further requests for
qualification for wind, but delays are to be expected.
There is no need for a developer that qualified under the
first request for qualification to submit a qualification application under a subsequent request for qualification that is
included in the same regulatory period, unless the developers
status changes.
The Egyptian Electricity Transmission Company or distribution
companies (depending on project sizes) are committed to purchase the electricity produced from renewable energy facilities
via power purchase agreements lasting 25 years for photovoltaic
facilities and 20 years for wind facilities at the last prices
announced by the Cabinet of Ministers.
The last prices announced by the Cabinet of Ministers for solar
photovoltaic facilities are as follows:
Tariff (per kilowatt-hour
Installed Capacity

in US)



Less than 200 kilowatts


(other than residential)

The department said in a formal opinion

released in November that it does not presently

intend to take any enforcement action. While it
is a basic principle of corporate law that a
company assumes certain liabilities when
merging with or acquiring another foreign
company, Justice said, [s]uccessor liability does
not . . . create liability where none existed before.
The target companys actions would not have
been prosecuted by Justice because the target
was not a US company.

An acquisition cannot create liability retro-

actively where there was none before.

The opinion is No. 14-02. The US government
took six months to issue the opinion.

signing new tax stability contracts with foreign


The contracts guarantee foreign companies

undertaking new projects in Chile that the taxes

that will apply to the projects will not change.
The Pinochet regime introduced the concept 40
years ago at a time when foreign investors were
skittish about investing in Chile. The government
says such assurances are no longer needed.

The proposal will have to be debated in

The government is proposing a four-year
transition after 2015 during which contracts
would still be signed, but guaranteeing a tax
rate of no more than 44.45%, the new rate
introduced in last years tax overhaul, com-

200 kilowatts to 500 kilowatts


500 kilowatts to 20 megawatts


20 megawatts to 50 megawatts


pared to the previous rate of 42%.

STATE TAX RATES are lower this year for corpora-

tions in seven states and the District of Columbia.

/ continued page 28

Arizona reduced its corporate income tax rate

from 6.5% in 2014 to 6.0% in 2015. Automatic
rate reductions were set in motion in 2011 that
will lead eventually to a 4.9% corporate tax rate
in 2017.
/ continued page 29

FE B RUA RY 2015



continued from page 27

The last prices announced by the Cabinet of Ministers for wind

facilities are as follows:
First five contract

Remaining 15

years (US)

contract years (US)

Hours of operation





























The above values are based on an exchange rate of US$ = 7.15

EGP, which was the reference rate used by the Egyptian Electricity
Transmission Company in the first request for qualification.
The Egyptian government has the right to reassess the tariff
either when the regulatory period lapses or when the capacity
target for the regulatory period has been met, whichever is
earlier. The reassessed tariff would only apply to new contracts;
tariffs under existing contracts remain fixed for the power purchase agreement term.

Regional Perspective
To put Egypts feed-in tariff values into perspective, the Jordanian
feed-in tariff stood at approximately US17 for solar photovoltaic
facilities and US12 for wind facilities: more generous than the
Egyptian regime.



F EB RUA RY 2015

Jordan was the first country in the Middle East and North
Africa region to implement a feed-in tariff. The incentive scheme
is viewed by many as the most important factor in kick-starting
Jordans renewable energy program, which arguably became a
regional template. Jordan is the first country in the region to have
successfully banked both wind and solar projects on an independent power producer basis.
However, the Jordanian feed-in tariff had limited application.
It applied only to the first round of renewable energy procurements. This included 12 solar photovoltaic projects ranging from
10 to 20 megawatts (excluding one project of around 50 megawatts) and one 117-megawatt wind project. Also, all solar photovoltaic projects procured under Jordans first renewable energy
procurement round were subject to an electricity production cap.
However, as Jordan moved on to its second renewable energy
procurement round, it dispensed with the feed-in tariff model
opting instead for a ceiling-tariff model. This model prohibits
developers from bidding over a certain tariff and incentivizes
bidders to tender the lowest possible tariff. The ceiling tariff is
currently set at US14 for solar photovoltaic facilities and US11
for wind facilities, very close to where Egypt has set its tariff.
In late 2014, the local utility in Dubai, the Dubai Electricity &
Water Authority (DEWA), tendered a 100-megawatt solar photovoltaic independent power project, the largest privatelyfinanced solar photovoltaic project to be tendered in the region.
On January 15, 2015, DEWA announced the appointment of
ACWA Power as preferred bidder and said that it had accepted
the Saudi developers alternative bid to provide a facility with a
capacity of 200 megawatts (on an alternating current basis) with
a startling tariff of US5.84869 per kilowatt hour over 25 years,
the lowest tariff ever witnessed anywhere in the world for a
privately-financed solar photovoltaic project. It will be interesting
to see whether this project sets a regional pricing benchmark for
solar photovoltaic projects or is viewed by the market as an
extraordinary result driven by intense competition and an IPP
model that provides for significant government support.
Time will tell how Egypt fine tunes its renewable energy procurement policy. In the meantime, as Egypt gets back on its feet
after several years of unrest, investors from all over the world
are flocking in to get a foothold into what is fast becoming a
renewable energy hotspot.

Community Solar
Models and Risks

The District of Columbia reduced its corpo-

rate income tax rate from 9.975% in 2014 to 9.4%

in 2015.

In Indiana, the rate went from 7.5% to 7%

and will fall to 6.5% after June 30. The rate will be

by Jake Seligman, in Washington

reduced by 0.5% a year through 2016, and then

Community solar projects are emerging as a new asset class,

distinct from residential, commercial, industrial and utility-scale
projects. It is still early, but lenders and tax equity investors are
beginning to invest.
Like any new asset class, community solar projects have
new risks to understand and allocate. This article explains
some of the risks and how community solar works in a typical
program, recognizing that community solar programs differ
by state and utility.
Community solar programs are cropping up around the
country. Eight states plus the District of Columbia have enabling
legislation in place. Colorado and Massachusetts lead in installations. Minnesota has also had significant activity. A handful of
other states are working on community solar legislation.
Enabling legislation is not always necessary. A study by the
Solar Electric Power Association counted 58 programs in 22
states, including those initiated by utilities and third parties in
partnership with utilities.

fall by another 0.25% a year until it reaches 4.9%.

The corporate income tax rate in North

Carolina fell a full percentage point, from 6% in

2014 to 5% in 2015. Future reductions are
expected, but will depend on general fund tax
collections the year before.

Rhode Island reduced its corporate income

tax rate from 9% to 7%.

In New Mexico, the rate fell from 7.3% to

6.9%. The rate will continue to fall by 0.3% to 0.4%

a year until it settles at 5.9% in 2018.

The Texas margin tax for retail and whole-

sale entities fell from 0.5% to 0.475%. The rate for

other entities fell from 1% to 0.95%.
BUILDINGS can be in service before they open

for business, a federal district said in late January.

A company that owns retail outlets that sell

home building materials and supplies completed

What is Community Solar?

two new buildings in Louisiana in December

A community solar project is a solar photovoltaic array, typically

around one megawatt in size, to which customers buy in or
subscribe. Projects are either ground mounted or located on large
roofs, like a commercial or industrial building.
A customer owns or subscribes to a portion of the project.
Customers can be residential, municipal, commercial or industrial
There are two main models. In a subscription model, the
customer pays the developer for its share of the output, usually
a fixed price per kilowatt hour per month or a fixed lease
payment, escalating with inflation. The customer can also prepay
the developer for all of the expected output from the customers
share of the project. In a purchase model, the customer makes
an upfront payment to buy a panel or series of panels.
The electricity from the project is delivered to the local utility.
The utility then credits each customer for that customers share
of the electricity output. The customer pays its normal bill to the
utility, reduced by the credit.
/ continued page 30

2008 that it intended to outfit as stores. Both

stores had received certificates of occupancy that
allowed them to receive and install equipment,
shelving, racks and merchandize. The stores were
not yet open for business, and the certificates did
not allow the public to enter yet.

Louisiana was still recovering at the time

from Hurricane Katrina. The US government

allowed companies putting new assets in service
in Louisiana to write off 50% of the cost immediately as a stimulus under so-called GO Zone
legislation to encourage rebuilding. The special
depreciation allowance only applied to assets put
in service during the period August 26, 2005
through December 31, 2008.

The company claimed the special deprecia-

tion allowance on the buildings. The IRS disallowed the deductions. It said the buildings were
not in service until they

FE B RUA RY 2015

/ continued page 31



Community Solar
continued from page 29

Before building a community solar project, the developer will

sign subscription agreements with customers. Subscription
agreements are similar to power purchase agreements in commercial projects. A typical term is 20 years from commercial
operation. The customer agrees to pay for all the electricity
produced by its portion of the project. Unlike a power purchase
agreement, the customer does not receive electricity from the
project. Rather, the customer is credited for the output to which
it subscribes.
Customers sometimes also sign reservation agreements, if
the project will not be built for some time. A reservation agreement simply reserves the customers spot (typically for a deposit)
for a period of time. The customer signs a subscription agreement before the project begins producing electricity.
A key element of the subscription agreement is the accounting and billing arrangement. The developer reports each customers share of the electricity output to the utility. The utility
credits the customers bill at a price set out in the state or
utilitys community solar program guidelines, similar to a net
metering arrangement. In the subscription model, the developer retains the environmental attributes, which it can sell to
the utility in a separate agreement. The developer also retains
the tax benefits.

from the whole project, then the utility will pay for the unsubscribed amount.
The amount the utility would pay in event of undersubscription is not as much as a subscribing customer would pay, but it
is a helpful backup. The utility usually pays a rate set in the
program guidelines equal to its avoided cost.
In the subscription model, subscriptions are transferable. If a
subscriber moves within the utilitys service territory, it can keep
its subscription. If a subscriber moves outside the service territory, it can transfer its subscription. Developers maintain waiting
lists, so new customers can join in place of customers who have

Why the Growth?

Community solar projects are growing as an asset class because

customers, developers and utilities all benefit from them.
Utilities benefit from community solar because they can
recover their fixed costs, while promoting growth of renewable
energy to meet state mandates. Community solar does not
necessarily contribute to any utility death spiral by picking off
utility customers and leaving utilities with stranded costs to
maintain the grid without the customer base to support it. The
customers remain with the utility, and the utility usually is able
to continue recovering its costs in the fixed portion of a customers bill.
Utilities can still charge customers fixed fees to recover the
costs of transmission and distribution infrastructure. Compared
to net metering, where a customer with solar can reduce the
fixed-cost portion of its bill to
zero, this arrangement is less
scary to utilities. Rather than
Community solar is gaining ground with the 80% of utility
crediting customers the retail
rate of electricity, as with solar
customers who are not candidates for rooftop solar.
net metering, the utility credits
them at a lower rate, which is
often decoupled from fixed
charges the utility might otherwise not recover. Customers are
typically allowed to offset 100%
The utility and developer have a separate arrangement for
to 120% of their electricity demand.
interconnection and electricity offtake. Many programs require
Utilities are also the accountants in the community solar
the utility to purchase unsubscribed electricity. For example, if
model. They bill customers and calculate the offset to each custhe developer cannot find enough subscribers to take output
tomers electricity charge from the customers portion of the

3 0


F EB RUA RY 2015

community solar project. Some developers, like Clean Energy

Collective, offer proprietary software to facilitate this
Customers also benefit. Community solar projects are often
compared to community gardens. They allow people who do not
own their buildings or have a roof on which to put solar panels
to subscribe to, or own, part of a community array.
Only about 20% of residential utility customers can host solar
projects. The remaining 80% may be renters, own apartments
or own homes with unsuitable roofs. Community solar programs
are designed to reach this 80% and often try to reach low-income
customers in particular.
Customers also do not have to worry about the complications
that come from having solar panels on their roofs. Community
solar avoids questions about roof repair, system maintenance
and what happens if a customer sells his or her house.
If a customer moves, the customer can usually transfer the
subscription to another customer that the developer finds (or
that may be on the developers waiting list). If the customer
moves within the utilitys service territory, he or she can keep the
Community solar is also good for developers. Projects are
often in the one-megawatt range, but can be larger, depending
on the program. This can give developers economies of scale,
relative to residential solar. As First Solars recent investment in
Clean Energy Collective showed, panels that are most economic
at larger scales can reach a market that includes residential, commercial and industrial customers.
Customer acquisition costs may also be lower. The pitch to
customers of community solar is possible savings and environmental benefits without the on-site construction or maintenance required for rooftop solar.

open for business, citing a matching principle

that depreciation should not start to run until an
asset has started earning revenue.

The federal district court disagreed. It said

the matching argument was totally without

merit. Allowing a 50% depreciation deduction
inherently offends the matching principle. It is
a tax subsidy purposely created to increase
business investments and stimulate the

The court said buildings are in service when

they are substantially complete. It does not

matter whether the retail outlets are ready to
receive customers.
The IRS cited a number of cases for the proposition that depreciation cannot start until a
retail operation is open for business. The court
distinguished all the cases as involving equipment (airplanes, power plants, an ethanol
distillery, grocery display counter) rather than
a building. The current case is Stine, LLC
v. USA.


come under fire.

The United States taxes US corporations on

worldwide income, but foreign corporations are

taxed only on income from US sources. This
means that a US corporation can defer US taxes
on earnings from its operations outside the
United States by putting the operations under a
subsidiary corporation in the Cayman Islands,
Bermuda, Holland, Luxembourg or another


country. The United States will look through the

There is interest from lenders, tax equity investors and even yield
cos in financing and acquiring community solar projects, but the
market is still feeling its way on risks.
Third-party ownership is a threshold requirement for domestic
renewable energy projects seeking tax equity investment. In
order to receive tax benefits from a project, a tax equity investor
must own the project. There are three main forms of tax equity
structures in use in the solar market. They may be hard to use in
community solar projects using the purchase model where the
customer owns the panels. Any tax equity investment would
have to use a pooled structure like a master sale-leaseback with
/ continued page 32
multiple customers as separate lessees.

offshore subsidiary and tax any dividends, interest or other forms of passive income received by
the subsidiary, but US taxes on income from
active business operations can be deferred until
the income is repatriated to the United States.

US multinational corporations look for ways

to have the use of the money in the United States

without formally repatriating it to avoid triggering taxes.
/ continued page 33

FE B RUA RY 2015



Community Solar
continued from page 31

The purchase model is usually more favorable from a securities

law perspective.
Community solar projects risk running afoul of state and
federal securities laws if the sale of interests or subscriptions is
considered a securities offering. Factors that bear on classification as a security include availability to the general public, the
number of subscriptions offered and the characteristic of the
subscriptions in the subscription agreement. Programs and
projects where panels are sold to customers should have less risk
of violating securities laws than those where a customer subscribes to an uncertain output. In the former case, the benefits
to the customer rely less on the developers future efforts.
If a subscription in a community solar project is a security, then
the developer would either have to register the offering or find
an exemption from registration. State legislators and market
participants are still working through the securities law issues.
In the meantime, agreements between developers and customers should be drafted to avoid potential securities law risk by, for
example, excluding words like share and investment and by
emphasizing the sale of electricity and the developers administrative role rather than an active decision-making role that could
affect the projects viability.
Cash flow to developers of community solar projects comes
from customer payments. In the subscription model, developers
may also have separate agreements with utilities to sell renewable energy credits or RECs.
Customers are typically a mix of companies, municipalities
and individuals. This mixture presents a more complicated risk
analysis to credit committees than in single-offtaker projects.
The market will eventually get used to it, but the first projects
take more time for credit committees to evaluate.
Some community solar programs require that a certain percentage (e.g., 5% in Colorado) of the participants in each project
be low-income residential utility customers. This requirement
introduces a new type of customer to the risk analysis. Investors
are used to residential projects whose hosts have FICO scores
above 650 or 700.

3 2


F EB RUA RY 2015

The low-income component in some community solar programs complicates tax equity financing. A developer in a subscription arrangement can improve the creditworthiness of a
community solar project by trying to have low-income customers
prepay, instead of making monthly payments over 20 years.
Having the utility provide backup payments for unsubscribed
amounts also is a form of credit enhancement. Credit committees can take comfort in knowing that if subscribers default,
there is still a base level of revenue from the utility.
Part of what makes community solar appealing to customers
is that if they move, they can either take their subscriptions with
them or transfer them to other customers. Developers often have
waiting lists for community solar projects, so they can transfer
a customers interest to a new customer with little delay.
Requiring a customer to provide notice of an intention to transfer
(e.g., 180 days) helps reduce risk.
There is more risk of an interruption in revenue in a project
with a few large subscribers or panel owners than one with many
small customers. It may be harder to replace a large customer,
even with 180 days notice.
Municipal customers require non-appropriation provisions in
their long-term power purchase agreements, including community solar subscription agreements. Non-appropriation provisions
allow a municipal customer to terminate its contract if the
municipality fails to appropriate enough money to pay for the
electricity. Although non-appropriation risk is hard to avoid with
municipal customers, provisions can be added to reduce risk. For
example, the municipality might agree not to sign a new power
contract with a third party for a set time after a non-appropriation event. Another common provision is a requirement that the
municipality use best efforts to re-appropriate funds after a
non-appropriation event occurs.
Utilities often want to own and operate community solar
projects directly. Recently, Xcel Energy, a leading utility in community solar efforts in Colorado and Minnesota, asked the
Colorado Public Utilities Commission for permission to own its
own community solar projects. The commission denied the
request preliminarily. Similar attempts by other utilities are

Crowdfunding: Good
Way to Raise Capital?
A number of solar and cleantech companies have been raising
money through the internet using an approach called crowdfunding. Some are doing this directly. Others are taking advantage of independent crowdfunding platforms that have matched
varied developers with potential cleantech investors. Is this a
good way to raise money? How does it work? What has been the
experience of companies that have tried it?
A group talked about these and other questions during a
roundtable discussion organized by Infocast in January. The following is an edited transcript. The speakers are Bruce Ledesma,
chief operating officer of Solar Mosaic and former executive vice
president and general counsel of SunPower Corporation, Tim
Newell, vice president of financial products at SolarCity and,
before that, founder and CEO of a financial technology company
called Common Assets that was acquired by SolarCity, and Jon
Norling, an advisor to GridShare, an internet funding portal for
crowdfunding investments in cleantech and renewable energy.
The moderator is Keith Martin with Chadbourne in Washington.
MR. MARTIN: Bruce Ledesma, what is crowdfunding?
MR. LEDESMA: Crowdfunding refers to the process of raising
money over the internet for a new business or product.
It started with donations- or rewards-based crowdfunding,
meaning that the people offering money get nothing in return
they make donations or they receive a free product or gift
a reward. Kickstarter popularized this concept. The model has
been enormously successful. Millions of dollars have been raised.
Our focus today is on something different. It is on what I would
call equity- or debt-based crowdfunding. A company issues debt
or equity securities to the public in exchange for money. This
version comes in a few different flavors.
One flavor is a company may try to raise money for working
capital. An example of a platform used for this purpose is Angels
List. Young companies can secure angel or series A-level financing
from the public for their own balance sheet use.
Another flavor is what my company, Mosaic, does. We issue
debt to the public and make the proceeds available to businesses
or consumers who want to buy solar systems. Mosaic focused in
the past on commercial projects but, last year, we pivoted to
making loans to homeowners who want to / continued page 34

Lending the offshore earnings to the US

parent does not work unless the loan is for no

more than 30 days. Up to two such short-term
loans can be made. If a loan is made for a longer
period, then the offshore subsidiary will be
treated as having repatriated its undistributed
earnings up to the amount of the loan.

A US company tried getting around this by

having its offshore subsidiaries with large

amounts of undistributed earnings make loans
to lower-tier offshore subsidiaries with fewer
earnings that then re-lent the money to the US

The IRS said it would treat the subsidiaries

that were the original source of the funds as the

real lenders and use their earnings to determine how much was repatriated rather than
focusing on the intermediate entities. It
addressed the strategy in an internal legal
memorandum that it made public in December.
The memo is Chief Counsel Advice 201446020.
The IRS is planning to issue guidance soon on
the treatment of loans by offshore subsidiaries to foreign partnerships with a US partner.
The issue is when and how much of such a
loan will be considered repatriation of earnings to the US partner.
WASTE HEAT engines moved closer to qualifying

for US tax credits.

The Senate tax-writing committee voted

February 11 to allow a 10% investment tax credit

to be claimed on the cost of new equipment that
uses waste heat to generate electricity. The heat
would have to come from one of two sources:
exhaust from an industrial process or a pressure
drop in gas used in an industrial or commercial
process. The equipment would have to be placed
in service by December 2016. It could not have a
generating capacity or more than 50 megawatts.

If the engine is integrated into the industrial

process, then the tax credit could be claimed on

only the incremental cost above what equipment
to capture waste heat without converting it into
electricity would cost.

FE B RUA RY 2015

/ continued page 35




as a go-between to allow customers who want to buy rooftop

solar rooftop systems to borrow the money to do so directly
continued from page 33
through crowdfunding.
install solar. To the extent we are sourcing our capital for these
MR. LEDESMA: We connect the borrowers to the crowd
homeowner loans from the crowd, we are engaged in what is
lenders, and we do that through our platform. Technically, Mosaic
known as peer-to-peer lending. There are lots of high-profile
issues notes to the crowd, but the crowd is linked to specific,
companies in this space outside of solar. The Lending Club is
underlying borrowers.
probably the most prominent and was the largest initial public
MR. MARTIN: Back-to-back lending, but the crowd has a speoffering in California last year.
cific customer?
MR. NEWELL: Crowdfunding is not a new phenomenon.
MR. LEDESMA: Exactly. The crowd lender has default risk
I would define it as use of the internet to enable smaller invesassociated with a particular project or individual homeowner
tors to participate in investments that were only available in the
or borrower. The payment obligations from Mosaic to the
past to large financial institutions. Its roots were in the 1980s
crowd are contingent upon the underlying linked borrower
and early 1990s with the emergence of on-line brokerages that
making its payments.
gave smaller investors access to initial public offerings for the
MR. MARTIN: How large are the loans?
first time. Since then, there has been a steady progression of
MR. LEDESMA: We provide loans ranging between $10,000
financial products that offer such investors direct access to
and $100,000 to residential customers. The average loan is about
everything from foreign exchange trading to mutual funds and
ETFs. The story of the last 15 to 20 years has been steady removal
MR. MARTIN: Is there also a commercial range?
of intermediaries through whom smaller investors had to go in
MR. LEDESMA: We have moved away from the commercial
favor of allowing direct investment.
business, but the loans we made in the past were between
At SolarCity, we issue bonds directly to investors using our own
$250,000 and $2 to $3 million.
platform, but there are many other ways you can do it.
MR. MARTIN: How much have you borrowed in total today?
MR. MARTIN: So, Tim Newell, crowdfunding is a natural evoluMR. LEDESMA: On the commercial side, we funded about
tion. The internet is displacing brokers.
$8.5 million during the two years that we ran that program. We
MR. NEWELL: Correct. A lot of the attention currently is on
just launched on the residential side and, in the last two quarters,
fixed-income and debt investments that is what peer-to-peer
we have signed agreements for just over $10 million. We have
and small business lending are about with a smaller share of
not crowdfunded those loans yet. They are in the queue, but we
capital going to equity investments.
have also brought institutional capital into the mix to supplement the crowd. We are feeding the institutional demand for the
Back-to-Back Loans
time being while we ramp up our residential program and we
MR. MARTIN: Bruce Ledesma, you said that Mosaic is using
see how those loans perform. We expect to start moving them
crowdfunding to engage in peer-to-peer lending, but I am conover to the crowd later this year.
fused about whether Mosaic borrows and relends or merely acts
MR. MARTIN: Two more questions for you and then I have a
series of questions for Tim
Newell. How long does it take
from the point you decide you
want to borrow from the crowd
to when the deal is struck? Is it a
day, a week, a month?
Mosaic uses crowdfunding to make long-term loans for
MR. LEDESMA: The process
should be continuous. We post
customers to buy solar systems.
residential opportunities and
watch the uptake rates, but, in
general, the loans should be

3 4


F EB RUA RY 2015

taken up almost immediately after posting. That was our experience with commercial loans.
MR. MARTIN: What interest rate, upfront fee and tenor does
the homeowner get on these loans?
MR. LEDESMA: We have different loan products with different
rates. Our flagship tenor is 20 years, and the rate is either 4.99%
or 5.99%, but rates can vary depending on the creditworthiness
of the borrower. We have another product that will be available
soon that is a 12-year loan. We are still hammering out the details
on the interest rate.
MR. MARTIN: That is the pricing on offer between Mosaic and
the customer, correct?
MR. MARTIN: This is a back-to-back borrowing. I imagine
you borrow more cheaply from the crowd, and the difference
is your margin?
MR. LEDESMA: Yes. We are paid an origination fee by the consumer like most consumer lenders receive, and then we provide
a return to the crowd whose amount depends on the product and
some other structuring considerations. The crowd return would
be somewhere in the range of 4% to 11%. The higher returns are
for loans to borrowers with lower FICO scores. The interest rates I
quoted earlier are for the most creditworthy borrowers.

The outlook for the proposal is unclear. It

must still clear the full Senate and House of
Representatives. There is no larger tax or
omnibus energy bill currently in sight to
which it might be added as a rider. Small tax
proposals like this do not pass Congress as
standalone measures.
FOREIGN INVESTORS in the United States are

hoping for modest relief from US taxes, perhaps

as part of a bill to provide funding for US highway

The highway trust fund runs out of funding

at the end of May.

The United States does not usually tax

foreigners on capital gains when they exit US

investments. The US needs foreign investment to
help fund US budget deficits. However, the
Foreign Investment in Real Property Tax Act
called FIRPTA requires that foreigners pay taxes
on capital gains from investing in US land, buildings and other real property. FIRPTA was
enacted in 1980 at the urging of family farmers
who were concerned that foreign demand for US

Solar Bonds

farmland was making it difficult for young

MR. MARTIN: Tim Newell, you are using crowdfunding to raise

debt rather than equity for SolarCity. How much have you
managed to raise to date?
MR. NEWELL: We are raising debt using our own crowdfunding platform, but we are doing something different than Mosaic
in that we are issuing solar bonds to raise corporate-level debt
for SolarCity directly rather than financing individual projects
or individual homeowners. SolarCity uses the money to install
solar systems that we own. We are aggregating tens of thousands of projects and issuing bonds whose interest payments
come from SolarCity and the monthly solar payments we
receive from our customers.
We launched our solar bonds platform in the fourth quarter
of 2014. We have not said publicly yet how much capital we have
raised through our direct platform, but what I can say is that we
have had thousands of people register on the site and have issued
millions of dollars in solar bonds.
MR. MARTIN: What is the term of the solar bonds? Twenty
/ continued page 36

families to buy their own farms.

Advocates for relaxing FIRPTA are looking for

two changes.

The Senate tax-writing committee approved

one on February 11.

Any person buying US real property from a

foreigner must generally withhold 10% from the

gross sales proceeds and remit the amount to the
IRS. A partnership or real estate investment trust
must generally withhold 35% of cash distributions to foreigners to the extent the distributions
are attributable to sales of US real property. The
foreigner can ask the IRS for a refund if the
amount withheld exceeds the taxes on the actual
gain. For example, suppose a foreigner sells a US
building for $100X, but at a profit or gain of only
$5X. The taxes withheld by the buyer in that case
will greatly exceed what the seller actually owes.
Smart buyers always ask for proof that the seller
is not a foreigner. A buyer / continued page 37

FE B RUA RY 2015



continued from page 35

MR. NEWELL: The initial bonds that we made available had

varying tenors. We offered different series of bonds with one-,
two-, three- and seven-year terms. The interest rates ranged from
2% to 4%.
MR. MARTIN: Why does SolarCity bother with this? Lyndon
Rive, your CEO, told us last fall that SolarCity needs to raise
$3 billion in 2015. This is just a drop in the bucket.
MR. NEWELL: It is a great question.
We have raised capital for some time now from a series of
large institutional and corporate investors like Goldman Sachs,
Google, Bank of America Merrill Lynch and others. We will continue doing that.
There are two reasons why we are also going to investors
directly through our solar bonds platform.
First, the number of banks and other financial institutions that
participate in renewable energy is growing rapidly, but it is still
an emerging investment sector and is a very small percentage
of the overall capital markets. When you are looking ahead to
having to raise billions of dollars a year to finance solar installations, it is important to open the door to a wider range of investors. We established our own platform to bring in a broad range
of investors not only individuals, but also small and mediumsized institutional investors to widen the market, to make our
capital raising efforts more resilient over any kind of economic
situation and, over time, to bring us the lowest cost of capital
and the least risk in raising that capital.
The second reason is that, while solar energy has had huge
growth, the transition from fossil fuel to clean energy will remain
a bumpy process that will require continuing public policy
support. The more people who feel they have a stake in the solar
economy, the better.
MR. MARTIN: Did I understand each of you correctly? Bruce
Ledesma, it sounded like each crowd loan is linked to a specific
customer so that the crowd lender takes credit risk of that single
customer. Tim Newell, it sounded like SolarCity is doing nonrecourse borrowings through solar bonds, but putting a portfolio
behind each bond. Is that correct?
MR. NEWELL: No, thats not correct on our part. We are issuing
corporate debt. The payments on the debt are made out of the
customer revenue we receive from large portfolios of solar
systems, but the debt is backed by SolarCity.

3 6


F EB RUA RY 2015

MR. MARTIN: Okay. Bruce Ledesma, did I describe Mosaics

structure correctly?
MR. LEDESMA: Yes. An investor will often allocate its investment across more than one borrower by funding a percentage
of each loan and diversify in that manner, but, yes, the loans are
non-recourse and the lenders are taking the customer credit risk.
MR. MARTIN: And each of you is doing this directly and not
going through an independent platform?
MR. LEDESMA: Correct for Mosaic.
MR. NEWELL: For SolarCity, we use our own solar bond
MR. MARTIN: Jon Norling you are working with an internet
funding portal, so I assume it is a platform for crowdfunding. You
heard about the two models that SolarCity and Mosaic are pursuing. What other models have you seen used successfully to raise
money for renewable energy or cleantech companies?
MR. NORLING: I dont think these companies have been
getting a lot of traction to date raising true investments from
the crowd. The market is still in its infancy and needs to be
proven. Equity crowdfunding is allowed today only in a limited
number of jurisdictions.
Going back to your first question, I see crowdfunding as way
potentially to raise a lot of small investments from many people
where the investment decisions are influenced by the crowd.
People see others joining a crowdfunding campaign. This builds
momentum, and that momentum helps the issuer reach its goal.

Five Paths to Market

MR. MARTIN: Lets focus on the legal underpinning for crowdfunding. First, are we talking about unaccredited investors or
accredited investors or both? Is there a legal barrier to trying to
raise money from both?
MR. LEDESMA: There are multiple paths to use of crowdfunding nationally. One path is to register the offering with the US
Securities and Exchange Commission, which is what SolarCity
has done, for example. It is an expensive and burdensome
process to register a debt offering if you are not already a public
company. It is really not a viable option, so everyone else needs
to look for an exemption from the registration requirement and,
today under the Jobs Act, there are three potential paths. Only
one of these is in use, and two are still in the rulemaking process
at the SEC.
The potential paths are title 2, title 3 and title 4 of the Jobs Act.
Title 2 probably received the least amount of media attention,

but is active today and is the closest model to free-form, unregulated capitalism in that it allows companies to blast the airwaves
and market offerings publicly with no maximum cap on the
dollar amount raised. There is no prospectus to file with the SEC,
but there is one major catch and that is that only accredited
investors can qualify and there are some fairly intensive verification procedures required where you must check peoples tax
returns or paycheck stubs and make other intrusive inquiries.
MR. MARTIN: What is an accredited investor? How much
income must he have?
MR. LEDESMA: He must have at least $200,000 annual income
or $1 million in net worth. Accredited investors represent about
7% of the US population.
The other two titles require SEC rulemaking before they
become available and the SEC does not seem overly excited
about them.
Title 3 has received the most media attention. It would allow
offerings to the general public and not just to accredited investors, and it allows general advertising, but it is limited to $1
million per 12-month period, so it is really aimed at young companies trying to get seed funding as opposed to project financing
or peer-to-peer lending. It is not a viable path for Mosaic because
of the $1 million cap per year.
Title 4 would also allow the general public to invest. It permits
general advertising and it raises the cap to $50 million per 12
months. We are very interested in seeing how that one unfolds,
but it has been taking some time and the rules are not final.
MR. MARTIN: Jon Norling, you are a lawyer also. Is there anything you want to add to what Bruce Ledesma just said?
MR. NORLING: We have been following the rulemakings
closely and have been preparing for the title 3 equity crowdfunding rules to be finalized. It looks like they will be delayed for
another year. Our offerings today are primarily Regulation D
offerings to accredited investors.
MR. MARTIN: That is what Bruce Ledesma called title 2?
MR. NORLING: The investors are limited. You are not getting
the true crowd. Accredited investors have a lot of options for
where to put their money, so it is tougher to get traction on a
crowdfunding website if the audience is limited to accredited
MR. MARTIN: Tim Newell, I assume SolarCity is also using what
Bruce Ledesma called title 2.
MR. NEWELL: SolarCity is a public company, and the crowdfunding options that were talked about / continued page 38

who fails to withhold will have to pay the sellers


Special rules apply to foreigners who hold

interests in US real property through real estate

investment trusts, or REITs. If the REIT is domestically controlled, meaning less than 50% of the
shares are held by foreigners, then a foreigner can
sell his shares in the REIT without being subject
to tax under FIRPTA, even if the REITs assets are
entirely US real estate.

As already noted, when a REIT distributes

cash to shareholders, it must normally withhold

35% of distributions to foreign shareholders to
the extent a distribution is attributable to a sale
of US real property. However, no withholding is
required on distributions to foreign shareholders
in publicly-traded REITs who own no more than
5% of the REIT shares. FIRPTA does not require
that such shareholders pay tax on gains.
Therefore, unless the distribution is considered a
dividend, it would not be subject to any US tax.

The Senate tax-writing committee voted to

increase the 5% to 10%. It also decided that

shares in publicly-traded REITs owned by persons
who own less than 5% of the shares will be
treated as domestically held unless then REIT has
actual knowledge that the shares are held by a
President Obama called in his budget
message to Congress in early February for a
second change. He wants to exempt foreign
pension funds from FIRPTA taxes on the
theory that this would put such pension
funds on an equal footing with US pension
funds. US pension funds are generally
exempted from US taxes. Advocates for the
change want to make it easier for foreign
pension funds to make badly-needed investments in US infrastructure.
/ continued page 39

FE B RUA RY 2015




then using that capital to make investments. You can also go

through a version of a venture capital firm. And, finally, you can
continued from page 37
make an intrastate offering where you are only taking investments from investors within the state and qualifying on the basis
either are not appropriate for us as a public company or do not
of a states laws. Therefore, Regulation D, Regulation A, BDCs,
give us what we want in terms of offering investment opportuniventure funds and intrastate offerings are your choices if you are
ties to the broadest number of investors. That is why we took
not going to do a fully-registered offering.
the path of using a fully-registered offering. If you are not going
MR. MARTIN: Let me come back to the states. That is a good
to take the path we chose, then you have basically five options.
list. I take it then that SolarCity did not need the Jobs Act to do
You could do a Regulation D offering like Bruce talked about
what it is doing with its solar bonds?
or a Regulation A offering. Both of those are available today
MR. NEWELL: The Jobs Act is an important step forward. It is
and . . . .
just not relevant to us. We want as broad an offering as possible,
MR. MARTIN: Stop there for a second. I am not sure our audiand the restrictions that are inherent in the Jobs Act would not
ence is following this. Regulation D is an offering to accredited
allow that.
investors with no limit?
MR. MARTIN: Is there a filing with the SEC that describes your
MR. NEWELL: Correct. There is no limit on the number of invessolar bonds?
tors or the amount you can raise with a Regulation D offering as
MR. NEWELL: Yes. We filed a shelf registration with the SEC
long as all the investors are accredited. The choice is whether you
last October for $200 million in debt, and we are currently issuing
are going to limit yourself to private discussions or do a general
solar bonds under that registration. You can go to the SEC website
and get all the details there. You
can also find the prospectus on
our solar bonds website.
MR. MARTIN: Let me ask one
more legal question and then
move to practical issues. The SEC
The SEC is expected to open the door later this year to
delay has let 13 states adopt
more forms of crowdfunding.
their own rules for crowdfunding by businesses in state from
state residents. Jon Norling, in
which states does investmenttype crowdfunding have traction due to state rules?
MR. NORLING: Wisconsin,
MR. MARTIN: What is Regulation A?
Michigan and Colorado have started some active crowdfunding
MR. NEWELL: Regulation A offerings are a form of registered
campaigns, although they are limited to investors in those states.
offering. Under Regulation A, you can approach any investor
We have seen an interesting intersection in Michigan and
not just accredited investors but there is a limit currently of
Colorado between community solar and crowdfunding. For
$5 million on the amount you can raise. That is what has been
example, Colorado has community solar legislation, and the state
proposed to go to $50 million.
crowdfunding rules present an opportunity to crowdfund comMR. MARTIN: So Regulation D is what Bruce Ledesma called
munity solar projects.
title 2, and Regulation A is what he called title 3.
MR. MARTIN: So if I am a Colorado business, I can raise money
MR. NEWELL: There are three other ways you can do this as
through crowdfunding in Colorado from Colorado residents
well. One is to go through a business development company. That
without the federal restrictions. What does it take to be a
is essentially putting together a public shell, raising capital and

3 8


F EB RUA RY 2015

Colorado business? Must my business be headquartered in

Colorado or is it enough to be doing projects in Colorado?
MR. NORLING: You need to be a state-registered business. All
of the states require a resident to be authorized and organized
to conduct business in the state. At least one state I forget
which allows foreign registration of a limited liability company,
and some require that at least 80% of the capital be used in that
MR. LEDESMA: Sticking with the general theme of different
approaches to an offering, if you are a public company that has
already gone through the arduous IPO process, as SolarCity has,
then registering a solar bond offering is a simpler exercise on
something called an S-3. The rest of us in the private company
world trying to do crowdfunding must find another path. The
Jobs Act only provides a path currently for offerings to accredited
investors. Tim Newell mentioned a few other avenues. One is an
intrastate offering.
Mosaic has decided to pursue such an offering in California;
we are a California-based company. We have created a Californiadomiciled entity to issue notes to the crowd. We have secured a
permit in California to crowdfund up to $100 million and it should
work fine, but of course we have to stay within California.

CALIFORNIA may have to pay refunds to passive

investors in limited liability companies that own

projects in California after a state superior court
judge held in November that such investors are
not doing business in California.

The state Franchise Tax Board is expected to


The case is called Swart Enterprises, Inc. v.

California Franchise Tax Board. Swart, a corpora-

tion formed in Iowa, operates a 60-acre farm in

Kansas that feeds cattle for beef sales. Swart
invested $50,000 for a 0.2% interest in a fund,
called Cypress Equipment Fund XII LLC, that
leases equipment to lessees in California. Swart
has no other ties to California.

The state collects a minimum tax of $800

from members in LLCs doing business in the

state. The Franchise Tax Board has been sending
overdue tax notices to LLC members. The notices
ask for $2,000 to $3,000 once penalties and interest are added.

Every corporation that is formed in California,

qualified to do business there, or actually doing

Practical Considerations

business in California must pay a minimum

MR. MARTIN: Lets move to some practical issues. How should a

company that wants to use an outside platform select one?
Platforms seem a little like Amazon for retailers; they offer a large
MR. NORLING: Time to give a plug for GridShare. GridShare is
a platform. We think the primary criteria for selecting platforms
should be a broad base of potential investors who are registered
with the site and who are excited about cleantech offerings, not
only making venture-type investments but also investing in
operating renewable energy projects either through debt or
being part of the sponsor equity.
MR. MARTIN: Is there data that someone can look at to evaluate your platform?
MR. NORLING: It is www.gridshare.com. You will find various
venture offerings on the site; for example, a company is looking
to raise money to tap hydrogen from animal waste. Another
wants to raise money to plant thousands and thousands of
hectares of jatropha for making biofuels.
MR. MARTIN: If someone wants to use a particular platform,
how can he determine how large an audience it has?

annual franchise tax of $800.

Doing business is defined as actively

engaging in any transaction for the purpose of

financial or pecuniary gain or profit. Anyone
holding an interest in an LLC that is a partnership
for tax purposes is considered by the Franchise
Tax Board to be doing business in California if the
LLC is doing business in California. Partners are
normally considered to do directly what the
partnership does.

A state superior court judge in Fresno County

ruled that holding a passive interest in an LLC is

not doing business in the state.

Another state tax agency, the State Board of

Equalization, takes the position that a limited

partner in a limited partnership is not doing
business in California solely by reason of holding
the partnership interest. The Franchise Tax Board
used to follow the same approach, but changed
its position in a ruling

/ continued page 41

/ continued page 40

FE B RUA RY 2015




Start there, and then ask yourself, Is Regulation A right for

me, where I reach general investors but in a smaller offering?
continued from page 39
Is Regulation D right for me where I focus solely on accredited
MR. NORLING: I am not aware of any data on audience size. It
investors? No matter which platform you choose, you are still
is an interesting point, though, and one that we will try to figure
going to use one of these methods to reach an audience of
out how to address on ours.
potential investors. There are not that many choices.
MR. LEDESMA: Let me add to what Jon Norling said about how
MR. MARTIN: Those are excellent questions. Jon Norling, when
to select a platform. I would focus on the track record: how long
someone uses your platform, has he in effect selected one of the
the platform has been around and whether there is a history of
routes that Tim Newell just mentioned and, if so, which one?
successfully-placed investments. That data should be displayed
MR. NORLING: He has. It is either a Regulation A or Regulation
on the platform. There should also be a clear answer to what
D offering at this point, although we are now starting to get
happens if the company that is managing the platform disaptraction in some states that allow intrastate offerings.
pears. Typically, you would expect to see an arrangement with
MR. MARTIN: What percentage of money raised should one
a backup servicing company that would continue to service the
expect to pay in fees?
payment streams from the borrowers to the lenders. Information
MR. NORLING: I know that the SEC just came out with a 15%
about it and any risks should be disclosed in the prospectus
figure all-in, with some of that being from the costs of audits
describing the platform.
and some of the other requirements for companies seeking to
MR. MARTIN: Tim Newell, you have been in this business for
raise more than $500,000 in an offering. I think the fees ultia while. If you were just starting out looking for a platform, what
mately will be in line with what you see for fees charged by
Google search would you do?
investment banks and financial
advisors, although we think, as
an internet portal, that we can
come in below that. You will still
have transaction fees to paper
the deal with lawyers. Our goal
Thirteen states allow crowdfunding by local companies
at GridShare is to have an all-in
fee in the single digits that will
from state residents.
include the accounting, the legal
work and the costs for hosting
the offering on the platform.
MR. MARTIN: Let me probe
there. An investment bank does
a lot of work. It does a road show.
MR. NEWELL: I would not start with a Google search. I would
It prepares a lot of documents a prospectus of some sort
first understand strategically what am I trying to achieve by
and it digs deeply into the company when preparing the prospecusing this method of raising capital: why use crowdfunding
tus. What does a platform do aside from providing an
instead of other more traditional forms of financing? Many
people think crowdfunding is a route to raising capital at lower
MR. NORLING: Lets look at the SEC proposed regulations and
cost or more quickly. I would be very careful about making
what the platform is allowed to do. The platform can assist the
either assumption.
issuer with the preparation of investment documents the
Crowdfunding has the greatest potential for companies that
prospectus, a kind of pitch book but the SEC was very clear
have a strategic reason for doing it; for example, a company has
that anything more than that in terms of doing due diligence and
a community-based project and wants to use this mechanism
advising on risks is considered providing investment advice which
to bring in community investments.
crowdfunding portals are prohibited from doing unless the portal

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is a registered broker-dealer. GridShare is not a registered brokerdealer, so it cannot provide investment advice. This has led to the
use of third-party service providers who work on behalf of the
issuer and provide some due diligence materials and some sort
of ranking for the project to help guide investment decisions.
MR. MARTIN: Is there a stigma against companies using
crowdfunding? I was at a roundtable discussion in Washington
last fall. Two small solar and energy efficiency companies said
that they will not use it for fear of such a stigma.
MR. LEDESMA: That sounds like what will eventually be antiquated thinking, certainly around Silicon Valley, which is an
innovative, disruptive culture. I suspect the fear is companies that
use crowdfunding will be viewed as having failed at securing
venture money from their own angel network so now they are
turning to strangers. If you are talking about the peer-to-peer
lending space, there is absolutely no stigma. Lending Club moved
$4 billion in loan volume last year and was the biggest IPO out
of California. I think that speaks for itself. A number of successful
companies are moving billions of dollars through peer-to-peer
platforms that are wildly popular.
MR. NEWELL: The use of the internet to raise money is relatively new, and the negative perception that often accompanies
anything new often has its roots in those participants in the
marketplace who may have the most to lose by the development
of a broader market. What you are seeing is the use of technology
to broaden a marketplace by allowing investors to have direct
access in ways they did not have before. It does not mean that
there wont be institutional investors participating in these
financings. In fact, if you look at models like Lending Club, the
crowd includes individual investors, hedge funds and banks
including very large banks as investors. That is how peer-topeer platforms tend to develop. The choice is whether to invest
with the crowd or along an institutional path. Many institutional
investors want to do all of the above, and technology is now
offering a way to do that. If this follows the same pattern as every
other part of the financial sector, then all of the major financial
players in the market will adopt this approach over time because
it expands the market.
MR. MARTIN: Bruce Ledesma, you described three titles of the
Jobs Act and said that the SEC has been slow to issue final regulations allowing two of them to be used. Until that happens, the
use of crowdfunding is limited to raising money from accredited

while the Swart case was pending. Its current

position is that each partner in a partnership
including an LLC treated as partnership is
considered to engage in whatever business the
partnership does. The ruling is Legal Ruling

The court said there is no legal authority for

this conclusion.

The LLC in which Swart invested put sole

control over the LLC in the hands of a manager

rather than leaving management to the
members. The Franchise Tax Board said Swart
relinquished a more active role by agreeing to
give the manager control. The court dismissed
the suggestion; Swart invested two years after
the LLC was formed.
The state could owe millions of dollars in tax
refunds unless the decision is overturned on
A MICHIGAN court said in December that sales

taxes must be paid on electricity sold to

telephone companies.

Michigan collects a 6% sales tax on sales of

tangible personal property. Electricity is considered tangible personal property. However, no tax
is owed if the buyer will use the article sold in
industrial processing, defined as converting or
conditioning tangible personal property for
ultimate sale at retail or use in manufacturing of
a product to be ultimately sold at retail. In other
words, the buyer must use the electricity to
produce another form of tangible personal
property that will be sold to consumers.

AT&T argued that it converts electricity into

telephone signals. The court said telephone

signals are a service rather than a tangible
product that one can hold or feel.
The decision came in a case called
MidAmerican Energy Co. v. Department of
Treasury before the Michigan court of
appeals. Detroit Edison, Consumers Energy
and AT&T joined in the suit.

/ continued page 42

/ continued page 43

FE B RUA RY 2015



continued from page 41

MR. LEDESMA: Or the intrastate exemption that we are using

in California, for example, to reach a broad potential investor
base, but composed entirely of California residents.
MR. MARTIN: The SEC final rules are expected when? Late
2015? Early 2016?
MR. LEDESMA?: I believe late 2015.
MR. NORLING: The latest we have heard is October 2015.
MR. MARTIN: The SEC is proposing that anyone raising more
than $500,000 must post audited financials. The SEC is concerned
about fraud. Critics say compliance with the proposed SEC rules
would add about 15% to the cost of any offering. Are the critics
referring to other things besides audit costs when they complain
about the burdensome proposed rules?
MR. LEDESMA: There are significant other costs involved with
this Regulation A+ approach that might be viewed as a mini-IPO
or S-1 type exercise. It is somewhere between a fully-exempt and
relatively-inexpensive offering and a full-blown million dollar IPO
process. Someone has to draft some version of a registration
statement that entails legal costs. There are the audit costs.
There are disclosure and risks and insurance that go with that
package, so the costs add up. The countervailing point is that
when you move to raise tens of millions of dollars from unsophisticated investors, there must be some level of regulated
disclosure, and there is a cost associated with that path, albeit a
lighter cost than a full registration. It is reasonable for the SEC to
require some process, but if the process becomes too expensive,
then it no longer is viable.
MR. MARTIN: Jon Norling, have any other equally burdensome
things been proposed besides posting audited financials?
MR. NORLING: The SEC had a pretty detailed breakdown of
what it views as the probable costs. The main items are audit
costs, the transaction costs for lawyers to paper the transaction
and the fees charged by the portal. The costs are expected to be
15% on average, but for smaller raises of under $100,000, the
estimate was that as much as 25% of the funds would go to
transaction costs, which I think would make small offerings
under crowdfunding really untenable, even though, at that level,
you would not have the audit costs.
It is unclear whether the auditor would have to be registered
with the Public Company Accounting Oversight Board, the
PCAOB, which can raise the costs of audits, or whether the

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F EB RUA RY 2015

auditor can be the companys local CPA. For a small start-up

company, there is not much to audit.
It should be noted that the SEC requirement to audit is in sharp
contrast to the 13 states that have adopted crowdfunding regulations. No audits are required in most states other than where
a company is seeking to raise more than $1 million. Then audited
financials are required. An audit is not triggered at the $500,000
level as in the SEC proposed regulations. Maybe the SEC will
increase its own trigger to closer to $1 million.

Falling Oil Prices

and Upstream
Insolvency Risk
by Kevin Atkins and John Verrill, in London

Collapsing oil prices are affecting projects and companies in the

oil and gas sector.
This article looks at how upstream joint ventures typically deal
with the risk of partner insolvencies and, in particular, what rights
host government and joint venture partners have upon an insolvency of a co-venturer.

Licensing Regimes
There are broadly speaking two main types of upstream licensing
arrangements: concessions and production-sharing or service
contracts. Aside from certain US states (such as Texas and New
Mexico) where title to oil and gas vests with the landowner, host
governments almost always have legislation vesting title to oil
and gas with the government, whether onshore or offshore, up
to the limits of the continental shelf. The licensing arrangement
is the means by which the host government grants oil and gas
companies the rights to search, drill and produce oil and gas.
Without a licensing arrangement with the host government, no
upstream oil and gas project can exist.
The concession structure is commonly used in Western Europe
and the United States. Under such a structure, oil and gas companies take title to production, and the host governments
revenue stream is then derived from fiscal terms (such as royalties and taxes) charged on production. However, under the

production-sharing and service contract structure, oil and gas

companies do not take title to any of the oil and gas produced
because title remains with the host government. The oil and gas
companies only have an economic entitlement to a pre-determined share of the production or in the proceeds of sale.
Under the terms of any licensing arrangement (whether under
the concession structure or the production-sharing and service
contract structure), host governments will be entitled to terminate the license upon an insolvency event of the oil and gas
company. However, where more than one oil and gas company
is participating in the upstream project (as is almost always the
case given the scale of financial commitments involved), the
insolvency of one licensee does not always give rise to an automatic termination right over the entire project.
For example, certain production-sharing contracts in Africa
do not give rise to termination rights in the event of the insolvency of fewer than all of the licensees if the project can still
be funded and work programs fulfilled. In the United Kingdom,
on the other hand, the insolvency of just one licensee, out of a
number of other licensees of the same license area, triggers an
automatic termination right. This makes the selection of joint
venture partners in an upstream project, whether as part of a
bidding round or as part of an approval of an entry of a third
party into the joint venture, incredibly sensitive. In some cases,
joint venture partner approval rights can hold up entire corporate sale transactions if those joint venture partners are concerned about the financial strength of the proposed incoming
oil and gas company. As a matter of English law, even absent
an express approval right, concerned joint venture partners
have an effective de facto approval right if the sale transaction
is conditioned on or otherwise requires novation documents
to be signed by all concerned joint venture partners. Any failure
or refusal to sign the transfer documents is tantamount to a
separate approval right.

NEW JERSEY cannot require power companies

to add back some taxes paid to other states when

calculating their New Jersey incomes, the state
tax court said in December.

liquid petroleum gas, residual fuels and coal in

New Jersey and, therefore, is subject to corporate
income tax in New Jersey. The state starts with
the net income a company reports for federal
income tax purposes and then makes adjustments. A company must add back income taxes
paid to other states.

Duke pays electric utility taxes in North

Carolina that are based on gross receipts. It also

pays a tax in South Carolina that is measured in
part by the value of its real property in the state.

The New Jersey tax court said neither tax is

an income tax that has to be added back. The

decision is in a case called Duke Energy
Corporation v. Director, Division of Taxation.

The same court held in October in a case

called PPL Electric Utilities Corp. v. Division

of Taxation that the parent company of

Pennsylvania Power & Light does not have to
add back a gross receipts or capital stock tax
that it pays in Pennsylvania.
AN ABANDONMENT LOSS can be claimed on a

power plant that was shut down, but not until an

arbitration against the manufacturer and
pending insurance claims have been resolved.

The IRS explained why in a private letter

ruling in December. The ruling is Private Letter

Ruling 201451014.

Joint Venture Arrangements

Duke Energy sells crude oil, refined products,

An electric utility owns interests in two large

pressurized-water nuclear power plants. Two new

Pursuant to the terms and conditions of licensing arrangements,

obligations of licensees are generally joint and several. Therefore,
one of the key drivers behind upstream joint operating agreements is to allocate risk on a several basis between the oil and
gas companies in the joint venture and to separate the joint liability regime under the licensing arrangement into percentage
interest shares in the upstream project.
This severance of interests also means in the UK that each
/ continued page 44
company is responsible for its own

steam generators were installed in each of the

plants, but a steam leak developed in a heat
transfer tube in one of the new generators. This
led to discovery of excessive wear and tear in
both plants after an inspection of all four steam
generators and eventually caused the utility to
decide to shut down both power plants permanently. The utility made a public announcement
that it was retiring both

FE B RUA RY 2015

/ continued page 45



Oil Prices

percentage interest bears to the total of the non-defaulting

parties percentage interests. Any failure to pay these additional
sums will itself be treated as a separate default. The defaulter
taxes since it lifts its own percentage share of oil and also has
will have his interest carried so that the project can continue, but
the benefit of tax losses from its proportionate share of costs.
default will also put additional strain on non-defaulting parties.
The separation of obligations works between the oil and gas
The consequences of a default usually escalate over time, with
companies only and not against the host government that
forfeiture being the ultimate and final remedy to the
awarded the licensing arrangement, who remains free to pursue
claims against any or all of the companies in the joint venture
The default usually begins with the defaulting party having
and will be most likely to take action against the companies that
restricted rights under the joint operating agreement. For
have the deepest pockets.
example, it will not receive joint venture information or be
Project costs are funded by cash calls made by a joint venture
entitled to attend and vote at joint venture meetings or exercise
party who is appointed to carry out the work, usually called the
any pre-emption rights or even take its share of petroleum. If the
operator. Each joint venture party pays cost and lifts oil in propordefault continues for a further period of time, then the defaulting
tion to its percentage interest share in the upstream project. Cash
party may be obliged to forfeit its interest completely and transcalls are usually made in order to fund the costs of work programs
fer its interest to its co-venturers. This will obviously only apply
that have been agreed between the joint venture partners on
to the particular project on which the default occurred and will
the basis of a voting procedure set out in the operating agreenot generally affect other projects that the defaulting party or
ment. This means that, to some extent, joint ventures can control
its affiliates have interests in, provided that the party is not in
the timing of expenditures by agreeing to work programs that
default under those projects, too. However, there will almost
are not especially onerous, provided, of course, that any commitalways be cross-default provisions in the financing documents
ments to the host government are satisfied. Typically, a cashthat will need careful scrutiny.
strapped joint venture party will want to slow down payment
In addition, in some joint operating agreements, each joint
and will be reluctant to approve new work programs that it
venture party may be bound to grant a security interest to each
believes it may not be able to afford. However, during the initial
other co-venturer over its percentage interest in the project, with
exploration phase of an upstream project, mandatory minimum
the co-venturers being entitled to enforce that security, if a party
work commitments will be required that will obviously necesdefaults, and sell the percentage interest to realize the amount
sitate significant capital expenditure that cannot be avoided.
owed by the defaulting party. This is in addition to the lien on
Any failure to pay a cash call will be treated by the operating
petroleum from which non-defaulters may recoup cash paid out
agreement as a default. Where one party is in default, the other
on behalf of the defaulter. However, the nature and enforceability
parties to the joint operating agreement will be required to pay
of such charges remains largely untested and, to date, we do not
the sums that are in default, each in the proportion that its
know of such a provision having been invoked in an international
upstream project. In any event,
as with any security interest, it is
important that such security is
perfected as a matter of law by
the security holders registering
Insolvency scenarios at troubled drilling projects hurt
particulars of the security in
accordance with local laws.
by low oil prices vary by licensing and joint venture
Unlike licensing arrangements, joint operating agreearrangement.
ments quite commonly do not
include a specific termination
right upon an insolvency of one
continued from page 43

4 4


F EB RUA RY 2015

of the joint venture partners. This is because of the fundamental difference in bargaining power and purpose between a
licensing arrangement and a joint operating agreement.
Under a licensing agreement, the bargaining strength is typically with the host government, which normally has a number
of interested bidders for acreage in a licensing round. The focus
of the licensing agreement is the extent and scope of duties and
obligations on the oil and gas companies with a view to maximizing host government revenues and the tax take such that, if and
when those things are at risk (for example, upon an insolvency
of one of the joint venture partners), the host government can
terminate the arrangement and seek new joint venture partners
as licensee.
A joint operating agreement is more collaborative with the
focus being on the integrity of the project in question and how
to carry out operations and bear liabilities for the project with a
view to a long-term and sustainable, successful and prosperous
operation of the project; hence, parties are under an obligation
to step in and remedy the defaults of others. Accordingly, insolvency is not itself a trigger to terminate a joint operating agreement. Additionally, in some jurisdictions ipso facto termination
for insolvency is unlawful under insolvency laws, but not in the
United Kingdom.

plants and told the US Nuclear Regulatory

Commission that the decommissioning process
will take several decades. It laid off a substantial
number of employees, got a reduction in its state
property tax base to reflect the impairment, and
wrote off its remaining investment in the plants
on its books.

The utility then commenced an arbitration

against the manufacturer of the defective steam

generators and sent a notice of potential claims
to its insurer. There are also ongoing proceedings
before the state public utility commission to
determine how the utilitys unrecovered investment should be addressed in the rates it charges

Section 165 of the US tax code allows a

company abandoning assets to claim an

abandonment loss to the extent the loss is not
compensated by insurance or otherwise. The
taxpayer must intend irrevocably to discard an
asset so that the asset will never be used again.
However, no part of the loss can be claimed as
long as there is a reasonable prospect of a

Insolvency Scenarios

Notwithstanding the contractual rights discussed earlier, in

practice (in the UK at least), license revocation in the event of
upstream oil and gas insolvencies is uncommon and, in the
most recent insolvency in the North Sea, the UK government
worked with the oil and gas company and the joint venture
partners concerned to maintain the project as opposed to
immediately looking to revoke the license. The political desire
to pursue further development of the North Sea, and the
awarding of tax reliefs in frontier areas (such as the West of
Shetlands) and the issuance of new variants to the traditional
licensing structure to facilitate continued development (such
as frontier and promote licenses that lessen the burden on
licensees during the initial exploration phase), also emphasize
the desire to keep upstream projects alive. Consequently, prepackaged sale arrangements are generally preferred exits from
formal insolvency proceedings as they ensure that the project
continues in the hands of a viable third-party purchaser and, if
done quickly, will reduce any administrators risk of becoming
personally liable for oil and gas operations.
In practice, even though joint venture / continued page 46

The IRS said in the ruling: If a taxpayers

claim is not speculative or wholly without merit,

and if the taxpayer believes that the chance of
recovering the loss is sufficiently probable to
warrant bringing a lawsuit and prosecuting it
with reasonable diligence to a conclusion, [then]
the deduction should be deferred until the
conclusion of the lawsuit.

In this case, the IRS said the tax deduction

should be deferred until the arbitration and insurance claims have been resolved. However, it saw
no need to wait for the rate proceedings before
the public utility commission since any increase
in rates to compensate the utility will not cause
the utility to be considered to have been
compensated for by insurance or otherwise.
The IRS also told the utility it can deduct the
amounts it spends on decommissioning
without waiting. Such spending is deductible
under section 162 of the US tax code as an
ordinary and necessary / continued page 47

FE B RUA RY 2015



Oil Prices
continued from page 45

partners have the right eventually to forfeit and effectively to

take over a defaulting partys percentage interest in a project,
the reality is that they will not force forfeiture unless there is a
commercial rationale for doing so and they have the financial
means to step in and fund the enhanced percentage interest
share they will be assuming in the project.
One issue with the obligation on co-venturers to step in and
remedy the default of a defaulting joint venture party is the
funding parties will be unsecured creditors of the defaulting
party who may also be insolvent or approaching insolvency.
Therefore, funding co-venturers may seek to prioritize their
claims over and above the claims of other creditors, but since the
funding obligation is in the operating agreement from the outset,
this is a desire not always achieved in practice. Why should the
defaulter agree? Moreover, the defaulters bankers will not want,
at the time of most need, to see their security eroded. Indeed,
most will have sought subordination of the joint operating agree-

high prices of the last four to five years and the boom in shale
gas have caused production to increase significantly and oil and
gas to flood the market. The return of major oil players such as
Libya, with its close to one million barrels per day, and Iraq has
caused supply to outstrip demand and has given consumers a
number of alternative sources of supply.
The dip in the Asian economy and the fall in Asian demand has
also had a drastic effect on prices and contributed in large part
to the over-supply problem. This is coupled with the stuttering
European economy.
OPEC in-fighting is also rumored to be a cause of the price drop
as members have, over the last few years, been fighting with
each other to capitalize on the growing Asian demand and are
now fighting to maintain their shares of that market and refusing
to reign in production levels to alleviate the problem of oversupply. Politically, some of the cause for concern of the OPEC
members may be driven by the US shale boom as US energy
independence has removed a previously-buoyant sale market
for OPEC crude, and some commentators have suggested that
OPEC members are prepared for the oil price to drop as low as
$35 to $40 a barrel for quite
some time, which would drive
competing producers out of the
market, before taking steps to
reduce production levels.

Effects of Oil Price Drop

Collapsing oil prices will bring
upstream projects closer to their
break-even points, with costly
deep-water projects in pre-salt
basins (such as offshore Brazil
and Angola), in particular, being
at significant risk.
This means that projects may
no longer be economic as
revenue streams from sales are
no longer enough to offset
funding obligations. Projects in
emerging markets that adopt production-sharing contract
arrangements will take longer to recover their capital expenditures from the proceeds of production, which will prolong when
they are able to become cash positive. Host governments will
also find that proposed licensing rounds are less active than
previous rounds as oil and gas companies are unlikely to take on

Host government consent may be needed for

lenders to foreclose on security.

ment liens and other co-venturer protections as a condition for

funding the project.

Falling Oil Prices

There are a number of reasons for the drop in the oil price.
However, perhaps the biggest single reason is over-supply as the

4 6


F EB RUA RY 2015

new projects with heavy exploration commitments at a time

of falling oil prices. This is already rumored to be the case in
Mexico where onshore projects, which generally achieve production faster than deep-water projects, are looking less attractive as production will be monetized at current sales prices. This
may mean that host governments consider either suspending
or postponing licensing rounds or, if oil revenue is a core component of the local economy, offering more competitive license
and fiscal terms to incentivize the continued development of
upstream projects. At the very least, it is likely that oil and gas
companies will re-assess their portfolios of projects and, where
possible, seek to pursue less risky onshore projects as opposed
to offshore drilling campaigns, as can be seen recently by a
number of oil and gas majors, including BP, Chevron and Statoil,
who have reduced their budgeted exploration capital expenditures for 2015.
The drop in price will cause lenders to think twice about offering credit lines to exploration-focused oil and gas companies as
exploration risk will be compounded by the lower revenue
stream if a discovery is even found. Additionally, existing loans
will be stress tested as the ability of oil and gas companies to
satisfy debt service covenants (in particular loan-life and projectlife coverage ratios) will be scrutinized. Lenders may look to
syndicate loan exposures to broaden the risk-sharing profile and
reduce their shares of funding particular projects (although
incoming lenders are unlikely to accept such risk without some
quid pro quo from the syndicating lenders).
This may eventually lead to events of default and acceleration
rights and enforcement of security under loan arrangements.
However, to the extent that asset-level enforcement is
pursued, this will require the prior consent of the host government as enforcement over the shares or assets of an oil and gas
company effectively constitutes a transfer of the interests in the
project to an incoming third party, which is routinely subject to
the prior consent of the host government. Host government
consents for transfers of interests in oil and gas projects are, as
a matter of local law, typically subject to the technical and financial competence of the incoming party. In the case of a lender
enforcing a security interest over an asset, the lender will rarely
be considered to have the appropriate technical competence to
conduct an oil and gas project. Therefore, in practice the host
government will likely work with the lender to locate a suitable
third party buyer for the asset in order to facilitate a sale for the
lender to realize the debt owed to it.

business expense. The possibility that the

utility might recover some of these costs in
the arbitration does not bar it from deducting
amounts spent on decommissioning now.
Any future recoveries for decommissioning
costs should be reported as income.

MI NOR MEMOS. US generating capacity

increased by 15,500 megawatts in 2014, bringing

total US capacity to 1,104,459 megawatts,
according to SNL Financial. Of the 2014 capacity
additions, 7,900 megawatts were natural gas,
3,800 were wind and 3,200 were solar . . . . Global
demand for new wind turbines was just under
47,000 megawatts in 2014, compared to annual
manufacturing capacity of 71,000 megawatts,
according to Navigant Research . . . . The IRS
issued 10% fewer private letter rulings in 2014
than the year before. Budget cuts imposed by
Congress mean the agency has no ability to
replace departing attorneys except for a handful
of critical hires, Erik Corwin, deputy chief counsel
(technical), said in January . . . . The fee the IRS
charges to handle private letter ruling requests
increased from $19,000 to $28,300 for ruling
requests filed after February 1.
contributed by Keith Martin in Washington

// continued
continued page
page 47

FE B RUA RY 2015



Oil Prices
continued from page 47

Where credit lines are squeezed and funding arrangements

pulled, oil and gas companies will look to make their asset bases
leaner and may look to corporate partners and potential joint
venture arrangements to share the risk of capital-intensive operating expenditures. However, the buyers market will be tight as
not many investors will look to take a stake in a commitment-rich
project that is in the exploration stage at a time when revenues
are falling. This may mean marketing to specific buyers in the
cash-rich Asian market (although Asian demand is falling and
growth rates are slowing) or otherwise seeking partnerships with
national oil companies that can manage relationships with host
governments, although national oil companies are frequently
funded during the exploration phase, meaning that they do not
pay their percentage interest shares.
An alternative to debt finance is to seek equity capital from
existing shareholders by way of a rights issue or from new investors by way of an offering. However, this will bring its own set of
issues as each incoming shareholder will require specific veto
rights and board seats and exit strategies that will affect the
broader corporate strategy of the oil and gas group. This will also
bring any shareholders with different investment profiles into
direct conflict with each other and could lead to stalemates with
board and shareholder decision-making leading to analysis of
shareholder agreements to see how such issues are resolved.
The drilling rig and oilfield services markets may also suffer as
assets are either under-worked or given up by joint ventures
withdrawing from projects. The assets most likely to be discarded
are those in the exploration stage where drilling commitments
are mandatory and substantial financial sums are required. This
will mean that drilling rigs and service operators are left underutilized, and supply will exceed demand. This will, as a result,
affect fleet prices and oilfield services charter party rates and
could, in the long term, have an adverse effect on new ship building projects in the Far East. This will also have a consequential
effect on oil-dependent projects such as refineries and associated infrastructure that will be postponed as project economics
cannot be supported.

4 8


F EB RUA RY 2015

Falling oil prices could also re-energize the debate about

delinking the natural gas price from the oil price as shale gas
players will not want a fall in oil revenues to cause a similar fall
in gas prices, especially as the steadily-increasing supply of gas
in the global market has resulted in natural regional hub pricing.
However, unlike offshore deep-water crude oil projects and the
heavy sour crude oil projects that require a large refinery expense,
a vast majority of onshore US domestic shale projects can still
remain cash positive and above the break-even line despite the
fall in process, although a sustained drop to a sub-$50-a-barrel
figure would test the economics of even those shale projects.
A long-term drop in the oil price will have a devastating effect
on resource-rich economies, a number of whom are OPEC
members, and may lead to widespread redundancies by major
oil and gas companies. For example, certain oil and gas companies active in the UK North Sea are already talking about mass
layoffs in 2015, and a number of North Sea investors are whispering about the imminent collapse of North Sea prospects.
However, broader global geopolitical concerns may be relevant, too. For example, the Russian economy is heavily supported
by oil and gas prices, and the lower oil price is having a disproportionate effect in Russia and is compounding the effects of
the existing US and European Union sanctions that restrict,
among other things, capital raising and oil and gas exploration
and production activities and sent the Russian ruble into a freefall against the US dollar. This may mean that the drop in oil price
is not seen as that bad a price to pay by the US as it imposes extra
pressure on the Russian economy.
On a longer-term basis, the US 2016 election cycle will start in
earnest in 2015. If the oil price continues to drop (or even if it just
stays at below the $65 mark), unemployment will rise in a number
of key electoral college states with active shale gas projects (such
as Texas and the notorious swing states of Ohio and Pennsylvania).
Accordingly, the US may put pressure on OPEC to cut production
and let the price normalize as each party seeks to give its presidential candidate the best possible chance of success and push
responsibility for the low price on the other party. Whatever
happens, 2015 will be a very interesting year as the oil and gas
industry and world leaders respond to the market.

An Expanding
US P3 Market
by Doug Fried, in New York, and Jake Falk, in Washington

A consensus is emerging in Congress that something must be

done about crumbling US infrastructure, but consensus remains
elusive about how to pay for it. Public-private partnerships may
end up being part of the solution.
This report provides an overview of the current US P3 market,
including information about the pipeline of projects in procurement, deal structures, market participants and public sector
It analyzes the trends and developments that are shaping the
US P3 market, how the market has matured in recent years and
where it may be heading in the future.
Chadbourne initially surveyed private involvement in US roads
on a P3 basis in 2004. While few deals had been done at that
time, a market for US P3s was emerging in the transportation
sector. Industry participants were encouraged by the Chicago
Skyway and Indiana toll road P3s in 2005 and 2006, respectively,
and were hopeful that a wave of US P3s was on the horizon.
However, political concerns and the financial downturn put off
or delayed some US projects, including some very high-profile
P3s that the industry had been pursuing. Nevertheless, the US
P3 market has continued to grow over the last 10 years.
During this time, P3 structures have matured, and P3 opportunities have diversified and increased. States have been procuring more greenfield P3s and using availability payment
structures for some projects. Certain states are developing
more predictable procurement processes, and the pipeline of
projects in procurement has generally become more reliable.
Global concession companies continue to set up US offices. P3s
are spreading to new states and cities and to new sectors,
including transit, social and water. A number of P3s are currently
in procurement, and more P3s are expected to be developed
for procurement in the future.

Growing US Pipeline
A number of new P3s are in procurement or being planned. More
than twice as many P3s could reach financial close in 2015 than
in 2014. Many are in the transportation sector.

P3s currently in procurement, a number of which may reach

financial close in 2015, include the Long Beach Civic Center in
California, the UC Merced Campus project in California, the
Escambia County waste processing project in Florida, the Illiana
corridor in Illinois (which was recently put on hold by the new
governor), the Illiana corridor in Indiana, the Indianapolis court
house, the University of Kansas campus project, the Purple Line
light rail P3 in Montgomery county, Maryland, a waste-to-energy
project in Prince Georges county, Maryland, the LaGuardia
Airport terminal building in New York, a rapid bridge replacement
project in Pennsylvania, a CNG fueling stations project in
Pennsylvania, the Port of Ponce P3 in Puerto Rico, the Portsmouth
Bypass in Ohio, State Highway 288 in Texas and the Houston
justice complex.
Several factors are contributing to the growing use of P3s in
the United States.
P3s can reduce project costs, including construction and longterm O&M costs, accelerate project delivery, allocate risks from
the public to the private sector and encourage innovation in all
phases of the project life-cycle.
Traditional federal grant funding available to states for transportation infrastructure is falling short, and the federal government is increasingly encouraging private investment in
infrastructure with new and expanded infrastructure financing
Significant amounts of private capital are available for investment in US P3s.
Infrastructure investment needs are clear in many cases based
on the condition, age and performance of US infrastructure
facilities and networks.
Sustainable, long-term sources of revenue are being approved
at the state and local level, such as sales taxes that can be used
to support project financings.
Public officials are becoming more familiar with P3s and are
establishing P3 offices, including, for example, in Virginia, Ohio,
Pennsylvania and Puerto Rico.
Early P3 projects are completing construction and opening for
operation, including, for example, the Capital Beltway and I-95
HOT lanes in Virginia, the Long Beach court house in California
and the I-595 managed lanes and Port of Miami tunnel in Florida.
The P3 delivery model is spreading to new states and also to
new sectors, including transit, airports, social, water and, most
recently, waste-processing infrastructure.
/ continued page 50

FE B RUA RY 2015



P3 Market

In some cases, the states identified in the chart are procuring

their first P3s, but cities or local agencies within these states have
continued from page 49
already closed a number of P3s. Examples are states like Illinois
A number of states that have closed P3s over the last 10 years
where P3s have been procured by the City of Chicago and
are leveraging their experience and developing more P3s. Some
Colorado where P3s have been procured by local agencies.
examples of P3s that these states have closed, are procuring or
Highway, bridge and tunnel projects continue to predominate
are planning are in the chart below.
in the US P3 market, but other infrastructure sectors are seeing
A growing number of states have turned recently to P3s for
more P3s.
the first time. Some examples of P3s that these states are procurTransit: The first major transit P3 in the US, the Eagle light rail
ing or are planning are in the second chart on the following page.
P3 in Denver, Colorado, is in full construction and is expected to
open in 2016. The Purple Line light rail P3 in
Maryland is now in procurement. In addition
to light rail, possible transit P3s could include
high-speed rail, commuter rail, bus rapid
transit, streetcar and intermodal station projTexas
SH 130 Segments 5 & 6 Open
North Tarrant Express Construction
ects, including, for example, the proposed
I-635 Managed Lanes Construction
Keystone corridor rail stations project in
North Tarrant Express 3A/3B Construction
SH 183 Construction
SH 288 Procurement
Social: The Long Beach court house P3 in
Pocahontas Parkway & Richmond Airport Connector Open
California opened in 2013, and there are curI-495 Capital Beltway HOT Lanes Open
five major social P3s in procurement in
Elizabeth River Crossings Construction
I-95 HOT Lanes Open
the United States: the Long Beach Civic Center
I-66 Corridor Improvements Planning/Development
(preferred proposer), the Indianapolis court
Indiana Toll Road Open
house (preferred proposer), the Houston
East End Crossing Construction
justice complex (shortlisted proponents), the
I-69 Section 5 Construction
Illiana Corridor (Indiana Portion) Procurement
UC Merced campus project (shortlist issued)
I-595 Express Lanes Open
and the University of Kansas campus project
Port of Miami Tunnel Open
(request for qualifications).
I-4 Ultimate Project Construction
Water: A handful of major water P3s have
reached financial close in recent years, includREPRESENTATIVE LIST OF TRANSPORTATION P3s
ing projects in Rialto, California and Bayonne,
New Jersey, and P3s are being considered for
Rapid Bridge Replacement Project Preferred Proposer
a water treatment facility in Miami-Dade
CNG Fueling Stations P3 Procurement
county, Florida and other projects. Congress
Keystone Corridor Rail Stations Project Planning/Development
recently created a pilot P3 program and a new
US 36 Express Lanes Construction
WIFIA loan program to support water P3s
I-70 East Planning/Development
that is based on the Transportation
Portsmouth Bypass Preferred Proposer
Brent Spence Bridge Planning/Development
Infrastructure Finance and Innovation Act
Illiana Corridor (Illinois Portion) Procurement
(TIFIA) loan program.
South Suburban Airport Planning/Development
Airport: The Luis Munoz Marin airport P3
Cape Cod Canal Crossing Planning/Development
in Puerto Rico reached financial close in 2012.
Route 3 South Express Toll Lanes Planning/Development
The central terminal building project at
Purple Line Light Rail Procurement
LaGuardia airport in New York is being proAlabama
Decatur Toll Bridge Planning/Development
cured as a P3, the Denver airport great hall

5 0


F EB RUA RY 2015

project is being procured as a P3, and Illinois is considering a P3

for development of the new South Suburban airport.
Other: A handful of parking P3s closed in recent years, including Ohio State Universitys parking P3 and Chicagos parking
meters P3, although no parking projects are currently in procurement. There have also been P3s for port facilities, including
some active procurements. These and other infrastructure
sectors, including waste-to-energy (there are currently two
projects in early stages of procurement), may see more P3 activity in the years ahead as the P3 delivery model becomes more
familiar and spreads to new parts of the country with their own
infrastructure needs.
There are also various US P3s in planning or development
stages that should support continued growth of the market in
the years ahead. This list includes the following possible P3s for
which requests for qualifications may be issued in the first part
of 2015: the I-70 East corridor project in Colorado, the Decatur
toll bridge project in Alabama, the SR 156 West corridor project
in California and the I-66 corridor improvements project in
Virginia. Additional P3s for which there may be RFQs in 2015
include, among others, the Cape Cod canal crossing and Route 3
South managed lanes P3s in Massachusetts and the Keystone
corridor rail stations P3 in Pennsylvania.
Of note, the November 2014 elections brought new leadership
to some of the states that have been actively pursuing P3s, which
could potentially alter the landscape for P3 activity in 2015 and

The number of public-private

partnerships reaching closing to
build out new US infrastructure could
double in 2015 compared to 2014.






2016. The impact of the elections will not be fully known until
the new leaders begin making decisions about infrastructure
projects during 2015.

Evolving P3 Structures
Deal structures for US P3s have matured and diversified over the
last decade. The US P3 market has evolved from an initial focus
on long-term leases of existing facilities and is now increasingly
focused on new projects.
There also seems to be a shift toward more availability payments and shorter concession periods.
Greenfield P3s: Since 2008, there have been more greenfield
P3s for development of new projects than brownfield P3s, or
leases of existing facilities. This shift coincided with the failure
of two high-profile brownfield P3s (the proposed Pennsylvania
Turnpike and Chicago Midway airport P3s), but also reflects the
growing familiarity of states with the P3 approach for developing
and delivering new infrastructure.
Availability Payments: Florida helped pioneer the use of
availability payments for greenfield P3s with the Port of Miami
tunnel and I-595 managed lanes P3s that each closed in 2009.
Indiana and California have also used availability payments.
Many of the states procuring their first P3s are using availability
payments, such as Pennsylvania, Ohio, Illinois and Maryland.
Toll Roads & Managed Lanes: Since 2008, many of the tollbacked P3 projects in the United States have been for develop/ continued page 52
ment of new managed lanes, with

FE B RUA RY 2015



P3 Market

Illinois, the Illiana corridor in Indiana, Marylands Purple Line,

Pennsylvanias rapid bridge replacement project (the Plenary
continued from page 51
Walsh Keystone Partners team consisting of the Plenary Group,
certain exceptions, such as the brownfield P3 for PR 22 in Puerto
the Walsh Group, Granite Construction Company and HDR
Rico and the Elizabeth River crossings P3 in Virginia. The managed
Engineering reached commercial close for this project on January
lanes projects often include high-occupancy toll lanes, dynamic
9, 2015), Ohios Portsmouth bypass (the Portsmouth Gateway
pricing to manage congestion, mass transit and other strategies
Group consisting of ACS Infrastructure Development, Inc.,
to provide drivers increased reliability and choice. The limited
Infrared Capital Partners Limited, Star America Fund GP and
number of real toll road projects reflects, in part, federal regulaDragados, USA, Inc. reached commercial close for this project on
tions that restrict tolling on interstate highways, which the
December 5, 2014) and SH-288 in Texas.
Obama Administration proposed loosening earlier in 2014.
More companies are participating in the US P3 market, includBundling P3s: Pennsylvania is packaging the replacement of
ing major engineering and construction companies, local and
several hundred bridges into one major P3 for its rapid bridge
regional design and construction firms and companies focused
replacement project, and it reached commercial close with a
on other types of infrastructure. However, the six P3s in this
consortium of Plenary, Walsh and Granite on January 9, 2015.
snapshot are representative of recent US highway and transit
This P3 could pave the way for additional bundling projects that
P3s and provide a good sense of the growing interest in this
come with their own set of risks and unique procurement issues
segment of the market.
that have to be structured appropriately.
Sixteen major US and global developers participated or are
participating on bid teams for these six P3s (including ACS/
Market Participants
Dragados, Alstom, Cintra/Ferrovial, Edgemoor, Fluor, Granite,
The diversity of companies participating in US P3s continues to
Isolux, Kiewit, Lane, OHL, Parsons, Plenary, Shikun & Binui,
increase as a growing number of US and global companies are
Skanska, Vinci, Walsh).
being named as preferred proponents for US P3s. For example,
Six equity funds participated or are participating on bid teams
Plenary (US 36 express lanes in Colorado) and Isolux (I-69 section
for these six P3s (Fengate, InfraRed, John Laing, Macquarie,
5 in Indiana) reached financial close on their first major US transMeridiam, Star America).
portation P3s in 2014, and Walsh, Vinci and Bilfinger Berger (East
One US developer (Walsh) participated or is participating on
End crossing in Indiana and Kentucky) did the same in 2013.
bid teams for five of the six P3s and another (Fluor) participated
Developers and Equity Funds: A snapshot of six major US
or is participating on bid teams for three of the P3s.
highway and transit P3s that were in the request-for-proposal
Two foreign developers (ACS and Cintra) participated or are
stage in the summer of 2014 shows the growing diversity of
participating on bid teams for four of the six P3s, and another
bidders for these P3s. The six projects are the Illiana corridor in
(Plenary) participated or is participating on bid teams for three
of the P3s.
Two of the equity funds (Meridiam and
InfraRed) were or are on bid teams for four of
the P3s, and the other equity funds were or
are on bid teams for two of the P3s.
Growing pipeline
Toll road leases
A number of the foreign developers and
lanes P3s
Mix of P3
Revenue risk
equity funds included in this snapshot have
Terms up to 99
set up offices in the US to facilitate their
New states and
involvement in these and other P3s, including
Major transit and
some that opened US offices in the last 12 to
24 months.

5 2


F EB RUA RY 2015


States With Broad

1. Arizona
2. Alabama
3. California
4. Colorado
5. Delaware
6. Georgia
7. Florida
8. Illinois

9. Louisiana
10. Maine
11. Maryland
12. Massachusetts
13. Mississippi
14. North Dakota
15. Ohio
16. Oregon

17. Puerto Rico

18. South Carolina
19. Utah
20. Washington
21. West Virginia
22. Wisconsin
23. Virginia

1. Alaska
2. Arkansas
3. Connecticut
4. Indiana

5. Minnesota
6. Missouri
7. Nevada
8. North Carolina

9. Pennsylvania
10. Tennessee
11. Texas

and Fire Pension System invested in two P3s

in Texas alongside Cintra and Meridiam, and
TIAA-CREF acquired an interest in the I-595
managed lanes P3 in Florida during construction, these types of investments are currently
not that common for US P3s.

State Activity

Thirty-three states and Puerto Rico have

legislation allowing P3s for highway and
bridge projects, according to the National
Council of State Legislatures.
7. Montana
13. Oklahoma
States With
1. Hawaii
Some of this legislation is broad, allowing
14. Rhode Island
No Legislation
2. Idaho
8. Nebraska
P3s for a variety of projects across multiple
Enabling P3s
3. Iowa
9. New Hampshire
15. South Dakota
sectors without further approvals, while
16. Vermont
10. New Jersey
4. Kansas
other legislation is more limited, and may
17. Wyoming
5. Kentucky
11. New Mexico
6. Michigan
12. New York
require additional legislative approval of P3s
or limit the number or type of P3s that state
agencies may undertake.
Many of the states that are delivering P3s
Lenders: Project sponsors in the United States obtain financare developing more predictable procurement processes that
ing to close P3s through tax-exempt private activity bonds, bank
work. States that are procuring their first P3s are learning from
loans and federal loan programs, in addition to equity and public
states that preceded them. (One of the Obama administrations
contributions. Other sources of financing might also be available
P3 goals is to share best practices among states.)
for US P3s, such as taxable bonds and institutional debt, but have
More states have been considering P3s in recent years than
not typically been used thus far to close P3s. While banks parpreviously, although not all of the states with enabling legislation
ticipated in most of the early P3s in the United States, they have
are currently pursuing P3s. States that are considering or procurnot been involved in many of the P3s, particularly the greenfield
ing their first P3s include Alabama, Illinois, Maryland,
P3s, that reached financial close after the market downturn in
Massachusetts, Ohio and Pennsylvania.
2008. This may be changing. For example, banks are providing
An emerging hallmark for success is the creation of state-level
senior debt for Floridas $2.3 billion I-4 ultimate project that
P3 offices or dedicated personnel that can coordinate public P3
reached financial close on September 5, 2014.
requirements and keep projects on track. States that have
The primary federal credit assistance programs used for P3s
created P3 offices or dedicated personnel in recent years to
are tax-exempt bonds and the TIFIA loan program, which remains
implement P3 programs include Virginia, Ohio, Pennsylvania,
critical to the financing of some transportation P3s. Tax-exempt
Indiana and Puerto Rico.
bonds and TIFIA are discussed below.
Some states accept unsolicited proposals for P3s, but the
Pension Funds & Institutional Investors: The US P3 market
majority of the P3s that have advanced through the procurement
has seen only a relatively limited amount of direct equity invest/ continued page 54
process have been solicited.
ment by pension funds and other institutional investors thus far,
despite the apparent alignment of their investment objectives
with infrastructures long-range returns. While the Dallas Police
States With
Limited or ProjectSpecific Legislation

FE B RUA RY 2015



P3 Market
continued from page 53

A few procurements have been cancelled after state agencies

shortlisted bidders. Most recently, Nevada elected to deliver the
I-15 expansion (Project Neon) as a design-build project rather
than a P3 after shortlisting three teams.

Federal Financing Support

Federal programs have played a significant role in financing US
transportation P3s. Of the 17 most recent major highway and
transit P3s to reach financial close in the United States identified
below, 14 used a direct loan from the TIFIA program, 11 used
tax-exempt private activity bonds authorized by the US
Department of Transportation, and nine used both a TIFIA loan
and tax-exempt bonds.
The 17 most recent major US highway and transit P3s include
the I-4 Ultimate project in Florida, I-69 in Indiana, US 36 express
lanes in Colorado, Goethals bridge in New York and New Jersey,
North Tarrant express 3A and 3B in Texas, East End crossing in
Indiana and Kentucky, I-95 HOT lanes in Virginia, Presidio Parkway
in California, Elizabeth River crossings in Virginia, PR 22 in Puerto
Rico, Eagle light rail P3 in Colorado, I-635 managed lanes in Texas,
North Tarrant express in Texas, Port of Miami tunnel in Florida,
I-595 managed lanes in Florida, SH 130 segments 5 and 6 in
Texas, and Capital Beltway HOT lanes in Virginia.
TIFIA: TIFIA provides low-cost, flexible loans for eligible transportation projects, which include both P3s and publicly-financed

The market is shifting from privatization

facilities to new construction.

5 4


F EB RUA RY 2015

projects. In 2012, Congress substantially increased the amount

of money TIFIA can lend from approximately $1 billion a year to
approximately $7.5 billion in 2013 and $10 billion in 2014. Also
in 2012, Congress increased the portion of a projects total costs
that a TIFIA loan can cover from 33% to 49%, but the government
has continued limiting loans to 33%.
More publicly-financed projects are advancing under the
expanded TIFIA program than P3s. Of the 44 letters of interest,
submitted for TIFIA assistance since the programs lending capacity was increased in 2012, 33 have been for publicly-financed
projects and 11 have been for P3s. The large number of publiclyfinanced projects is not likely to crowd out P3s as long as
Congress continues to provide sufficient budget authority for
TIFIA to make loans to all of the projects that are requesting
Private Activity Bonds: Private activity bonds are tax-exempt
debt instruments issued by public agencies on behalf of private
developers. Authority to use the bonds is granted by the US
Department of Transportation for eligible highway and transit
projects. Congress established a national limit of $15 billion on
the use of such bonds when it created the program in 2005. As
of November 12, 2014, $10.2 billion of the $15 billion cap had
been allocated to eligible projects, and $4.8 billion of bonds had
been issued. As the amount of allocations begins to approach
the $15 billion cap, Congress would have to authorize a higher
limit for the program to remain viable. Tax-exempt bonds are
also available for certain water, waste and other types of infrastructure projects that may be financed through P3s.
TIFIA and private activity bonds
have featured so prominently in
US highway and transit P3s
because they help reduce financing costs. TIFIA has also been particularly helpful for toll road P3s
because TIFIAs flexible repayment provisions can better match
of existing
projected cash flows.
WIFIA: The federal government recently created a Water
Infrastructure Finance and
Innovation Act program called
WIFIA that is modeled on TIFIA.
The program allows each of the

US Environmental Protection Agency and the US Army Corps of

Engineers to make flexible, low-interest loans for water projects,
including P3s. Various types of water and wastewater projects
are eligible.
National Infrastructure Bank: Since 2007, many proposals
have been offered in Congress for a new national infrastructure
bank, but none has passed. The failure of these proposals is
attributable, in part, to the difficulty of passing substantial new
spending measures during an economic downturn and to a polarized Congress. The failure may also be due to the success of
sector-specific programs like TIFIA that provide many of the
benefits that an infrastructure bank would provide at a low cost
to the taxpayer.

Traditional Public Funding

Federal Transportation Funding: Public officials are turning to
P3s for transportation, in part, because traditional federal
highway and transit spending is falling short. Federal transportation spending has relied on revenue from motor fuel taxes since
1956. These revenues have supported a federal Highway Trust
Fund that provides grants to state and local governments to pay
for highway and transit projects with currently-available funds
rather than borrowing. However, Americans are consuming less
fuel, and federal motor fuel tax rates have not been raised since
1993, leaving the Highway Trust Fund short of funds.
According to a June 2014 report from the Congressional
Budget Office,
The federal government spends more than $50 billion
per year on surface transportation programs . . . [but in]
the past 10 years, outlays from the Highway Trust Fund
have exceeded revenues by more than $52 billion, and
outlays will exceed revenues by an estimated $167
billion over the 20152024 period [at current spending
and tax rates].
Since 2008, the federal government has addressed these
shortfalls by making transfers from the US Treasury general fund
to the Highway Trust Fund. The 2012, the federal highway and
transit bill known as MAP-21 did not provide any significant
new revenues for transportation programs to address the shortfalls. Congress had until September 30, 2014 to reauthorize
MAP-21 before the programs expired, but pushed off the deadline to May 31, 2015, largely because it could not solve the

funding problem. President Obama proposed a $302 billion

reauthorization of MAP-21, but this is more spending than the
Highway Trust Fund can support.
The federal shortfalls over the last several years have helped
push federal policymakers to consider new approaches for
funding and delivering infrastructure, including P3s. Both
Congress and the Obama administration have launched initiatives to explore the possibility of expanding P3s.
House P3 Panel: The House Transportation and Infrastructure
Committee created a special panel in January 2014 to focus on
P3s across various types of infrastructure. The panel produced
a report on September 17, 2014, and the panels work may lead
Congress to encourage broader use of private-sector investment and P3s when Congress considers new infrastructure
Build America Initiative: In July 2014, the Obama administration launched a Build America Investment Initiative to encourage broader public and private sector collaboration and expand
opportunities for P3s. The initiative includes a new Build America
center at the US Department of Transportation to serve as a
one-stop shop for cities and states seeking to use innovative
financing and partnerships with the private sector to support
transportation infrastructure. The administration also created
an inter-agency working group to focus on P3s with more than
a dozen agencies and offices participating. The group will review
ideas and make recommendations to promote broader use of
P3s for US infrastructure.
State and Local Funding: With federal grant programs for
transportation facing shortfalls, state and local governments
have been creating new, dedicated sources of revenue for transportation infrastructure. Some of these sources of revenue are
being leveraged to support infrastructure investment using
innovative financing approaches, including P3s. Using new
sources of revenue and innovative financing approaches allows
cities and states to advance major projects in the near-term
without waiting for new federal funding.
Some of the most significant local efforts to raise revenue are
referenda that allow local voters to approve new sales and use
taxes and dedicate the revenue to specific projects. One of the
most substantial voter-approved sales taxes in recent years was
the half-cent Measure R sales tax approved by voters in Los
Angeles in 2008. Measure R revenues will be used to fund a
number of transportation projects to be / continued page 56

FE B RUA RY 2015



P3 Market
continued from page 53

delivered by the Los Angeles county Metropolitan Transportation

Authority, including possible P3s. Local sales taxes also fund the
Denver Regional Transportation Districts projects, including the
Eagle light rail P3.
Some states have also recently been supplementing state
motor fuel excise taxes with other long-term taxes that can be
dedicated to transportation. These include increased motor fuel
taxes, dedicated sales taxes and increased fuel taxes at the
wholesale level.

Transportation proposed that Congress provide more flexibility

for states and cities to charge tolls on interstates. This proposal
was in the draft highway and transit bill that President Obama
sent Congress to replace MAP-21.


The US P3 market is growing and will continue to do so due to

shortfalls in federal grant funds, the need to invest in aging and
inadequate infrastructure, availability of private capital and
public sector efforts to improve the financing and delivery of
projects. The growth is also aided by the growing familiarity of
public officials with P3s, the completion of early P3s and the
effectiveness of the P3 delivery
There are currently several P3s
in procurement or being planned.
Some of the upcoming opportunities for the private sector to
invest in US P3s include the following potential P3s currently in
Thirty-three states and Puerto Rico now have legislation
procurement or expected to
move there:
allowing use of P3s for highway and bridge projects.
I-70 East corridor project (CO)
An approximately 11-mile,
$1.5 billion project to add capacity and managed lanes on I-70
East from downtown Denver
toward Denver International
airport. A request for qualifications is expected in early 2015.
CNG fueling stations P3
Tolling and Pricing: One significant reform that the federal
project for transit (PA) An approximately $50 to $100 million
government could make to help states raise revenue for transproject to install CNG fueling stations at up to 37 transit facilities
portation projects would be to relax the current restrictions on
across Pennsylvania. The shortlisted bidders were announced on
tolling interstate highways. By creating a dedicated source of
January 16, 2015.
revenue that can be used by private entities to pay debt service
Decatur toll bridge (AL) An approximately $250 million toll
and receive a return on equity or to allow states to make availbridge P3 proposed for northern Alabama connecting Morgan
ability payments, tolling would facilitate more P3s. Some states
and Limestone counties over the Tennessee River in Decatur. A
have expressed interest in tolling interstates in recent years to
request for qualifications is possible in 2015.
make critical improvements and replace aging and, in some
cases, inadequate infrastructure. In 2014, the US Department of

5 6


F EB RUA RY 2015

I-66 corridor improvements (VA) An approximately 28-mile

managed-lanes project on I-66 from Haymarket in Prince William
county west of Washington to the Capital Beltway. A request for
qualifications is expected for this P3 in early 2015.
Port of Ponce (PR) A port operations P3 at the Port of Ponce
in Puerto Rico with opportunities for additional improvements.
A request for proposals was issued for this P3 in October 2014
describing the shortlisting and bidding process.
Prince Georges county waste processing and alternative
energy facility (MD) A P3 to construct a new waste processing
and conversion facility for Prince Georges county. A request for
qualifications was issued in October 2014.
South Miami Heights water treatment plant (FL) A P3 to
construct a new water treatment facility for Miami-Dade county.
A draft request for qualifications was issued, and a final RFQ is
expected in 2015.
SR-156 West corridor (CA) An approximately $268 million
project to construct a new highway parallel to Highway 156 in
Monterey county. A pre-development agreement could be
awarded in 2015 following an RFQ-RFP process.
University of Kansas Central District development project
(KS) A P3 for the planning, design, construction, financing and
potentially operations and maintenance of the Central District
development project. Responses to the request for qualifications
were received on January 15, 2015.
Emerald Coast/Escambia county waste processing facility
(FL) A P3 for the design, permitting, financing, construction and
long-term operation of a waste processing facility. The shortlisted bidders were announced on January 7, 2015.
More solicitations are expected later in the year.

Current Trends:
Industry Chatter
A panel of power industry veterans had a wide-ranging discussion
in New Orleans at the Infocast projects & money conference in
January about the impact of falling oil prices on the US power
sector, whether the basic power industry business model is being
turned upside down by cheap natural gas and distributed solar
and, if so, what emerges as a new business model, whether distributed solar is a good place to invest capital and other topics.
The panelists are Nazar Massoud, a principal with Energy
Capital Partners and a former Goldman Sachs managing director,
Todd Carter, senior partner and founding president of Panda
Power Funds, Joe Kerecman, director of government and regulatory affairs at Calpine, Scott Taylor, chief financial officer of
Moxie Energy and a former managing director in the wind and
solar groups at AES Corporation, and Grant Davis, managing
director of Tenaska Capital Management. The moderator is Keith
Martin with Chadbourne in Washington.
MR. MARTIN: The power industry business model appears to
be undergoing as significant a transformation as after the Arab
oil embargo in the 1970s when the independent power industry
was born. In 1978, the US Congress ordered utilities to buy electricity from independent generators. This led to deregulation of
the generation side of the business in many states. Now it seems
like we are reinventing things again and are entering another
period of significant change in the basic power industry business
model. Nazar Massouh, do you agree?
MR. MASSOUH: I agree that we are going through a big transformation. Some of it is driven by forces within the power industry itself. Some of it is driven by the Environmental Protection
Agency. Some of it is driven by forces in the oil and gas industry.
I have had the pleasure of working across industries, and I would
say that the latter probably has had the biggest impact on the
power industry by lowering natural gas prices from where they
were in 2008. In preparing for this panel, I looked at where gas
prices were in the 1990s and, surprisingly, they were about the
same as they are today.
MR. MARTIN: So as transformational a period today as after
the Arab oil embargo. Todd Carter, do you agree?
MR. CARTER: I completely disagree. [Laughter.] We are an
/ continued page 58
independent generator building power

FE B RUA RY 2015



Current Trends
continued from page 57

projects in different parts of the country. We have not seen

much change in how we do business. Low gas prices are creating opportunities for us to build more power plants, but the
basic business model is the same as in the past.
MR. MARTIN: One yes. One no. Joe Kerecman, major transformation or not?
MR. KERECMAN: My frame of reference is PJM. There were
797,000 gigawatt hours of energy produced in PJM in 2013. Of
that, about 1,948 gigawatt hours came from oil, so oil-fired
generation is practically non-existent. Solar was only 355 gigawatt hours in 2013. Wind was 15,000 gigawatt hours. The story
in PJM today is about how nuclear is suffering, coal is in transition, and gas is picking up market share because of low natural
gas prices. There is a lot of opportunity for independent generators not only because of low gas prices, but also because PJM is
changing its capacity market design with higher performance
expectations on which some of the intermittent resources will
not be able to deliver.
MR. MARTIN: Does that mean transformation in the basic
business model or is it just more of the same with independent
power producers seeing some new opportunity in PJM?
MR. KERECMAN: There is a greater opportunity to develop in
MR. MARTIN: Scott Taylor, are we in a transformational period
as significant as the late 1970s?
MR. TAYLOR: I agree with Todd Carter. I think this is just an
extension of the existing business model and not a period of

Merchant power plants are expected to

financeable in New England.

5 8


F EB RUA RY 2015

transformational change. It is consistent with what was intended

to occur in 1978 with enactment of the Public Utility Regulatory
Policies Act and its mandate to utilities to buy from independent
generators. Our industry has seen changes in the generating mix
over the last 35 years. Think about some of the rice hull projects
that we financed in the early years. Geothermal was big. There
has been a gradual shift in the generating mix, but even the
growth in renewables, some of which, like rooftop solar, involves
significantly disruptive technologies, is still playing out against
a backdrop of the same basic business model.
MR. MARTIN: Grant Davis, same business model?
MR. DAVIS: I disagree with Todd Carter. We are in a transformational period. I dont know whether it will take five years or
10 years to play out fully, but the power industry is in the midst
of some fundamental changes in how it has operated over the
last 20 years.

Major Transformation?
MR. MARTIN: Nazar Massouh, you think we are in a period of
transformational change. What emerges at the end of this
MR. MASSOUH: The oil and gas industry is having a big impact
on our sector, perhaps not for the reasons that are obvious
because we no longer use oil to produce electricity, but we do
use natural gas. Gas was $13 an mmBtu before prices collapsed.
Prices would have come right back up, just like they did for oil,
except they never recovered because of unconventional techniques for producing gas. Furthermore, close to half of our
natural gas produced unconventionally is actually associated gas.
It comes out of oil wells and is associated with oil production.
The reduction in oil prices could
lead to a reduction not only in oil
output, but also output of associated gas. That could put upward
pressure on the price of natural
Low gas prices are what has
allowed us to do a lot of things in
the last five or six years.
I feel sorry for people in the
renewable energy space because
low gas prices are making life

difficult. If gas prices were still $13, we would have a lot more
renewables, and we would have coal plants that would be retrofitted instead of being shut down. I dont know whether the
coal generating capacity that will be shut down will reach
100,000 megawatts, but it should be close to that number.
I started with an independent power producer in the mid1990s, and the first thing I learned was the stack works: you
dispatch hydro, nuclear, coal and gas in that order. What is happening is transformational because the traditional stack no
longer holds.
MR. MARTIN: What is the current stack?
MR. MASSOUH: Hydro and nuclear are still there, but natural
gas is by far the cheapest source of production outside of the
renewable energy producers who do not have to buy fuel.
MR. MARTIN: So the transformation is not so much in the
business model as a shift in who supplies electricity?
MR. MASSOUH: More in what energy sources are used to
generate our electricity rather than who generates it.
MR. MARTIN: Grant Davis, you believe we are in a transformational period. What emerges at the end of it?
MR. DAVIS: That is a good question. If I had the answer, I
might have earned enough to retire by now. I think 10 years
from now, we will look back and see some fundamental
changes. The mix of generating assets or the stack is an obvious
one. I think we will see changes in the regulatory environment
relative to renewables, relative to demand-side management
and the utility model. There is pressure to move away from sole
concentration on large generating stations to more of a distributed generation model.

More of the Same?

MR. MARTIN: The rest of our panel believes it will be more of the
same. Todd Carter, is it easier or harder today to get a power
contract with a utility?
MR. CARTER: The changes that the gentlemen are talking
about are not driven by falling oil prices. We are in a transformational period in the power business.
MR. MARTIN: Transformation to what?
MR. CARTER: We are building power projects that use natural
gas. Gas has been the biggest game changer of all the trends that
are visible today in the market. Low gas prices put pressure on
renewables. They put pressure on coal. They will lead to a reduction in carbon emissions as gas replaces coal. The reduction will
not be the result of government regulation, but economics.

I agree with Grant Davis about utilities and distributed generation. It is a different business today than it was 35 years ago.
Everything is different. You have to stay on top of the changes
and be at the forefront of the transformation.
MR. MARTIN: It is a harder business today because you do not
have long-term power contracts for your projects. You are building gas-fired power plants that sell on a merchant basis into PJM
and ERCOT.
MR. CARTER: No doubt it is a tougher business for independent
generators. There are people in our business who are waiting for
a 30-year power contract, they are waiting for a 20-year contract,
they are waiting for a 15-year contract. Guess what? That model
and that business shut down more than 10 years ago. There are
still some long-term power contracts to be had, but they are few
and far between, so we look to build in markets where the additional electricity is needed. Texas is a fast-growing market. It is a
different place than PJM with its older asset base, but we like the
transparency of both markets.
MR. MARTIN: Scott Taylor, you think it is more of the same.
MR. TAYLOR: I should clarify that. I agree with the comments
just made. I am not suggesting that there are not big changes
going on with coal going away and gas replacing it. I was more
responding to the suggestion by NRG CEO David Crane that the
market will turn upside down: IPPs and utilities will go the way
of the dinosaur and consumers will turn to distributed generation. I am not suggesting that distributed generation will not
have an impact on our industry, but that impact will be a lot
smaller than many predict and, at the end of the day, we will still
have a healthy IPP business and a healthy utility business.
Each of us must adapt to the changes, but the basic business
model will remain. Utility-scale projects will still be needed to
serve demand. I am not saying that renewables and distributed
generation will not benefit from some of that growth, but the
distributed generators are not going to turn the market upside
down in the same way that gas has turned the market upside
down by slowing the adoption of renewables and replacing coal.
The industry is in a slow evolution of the sort that Congress set
in motion in the late 1970s; nothing more.

Falling Oil Prices

MR. MARTIN: Lets drill down into several factors that affect
the market, starting with oil prices. They have been dropping
dramatically. Oil is under $50 a barrel today. Some people think
the price will fall as low as $30 a barrel / continued page 60

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Current Trends

MR. KERECMAN: PJM and New England are moving to capacity

markets that reward performance. There are severe consequences
if you do not perform. What we are doing at Calpine is relying on
before turning around. What are the effects of the falling oil
dual fuels. We have some oil peakers in PJM, but the rest are
prices on the independent power market?
combined-cycle gas-fired power plants with oil as a backup fuel.
MR. DAVIS: I think there is very little impact. We will end up
Lower oil prices reduce the cost of the backup fuel, but it is not a
with less associated gas as oil wells are shut down. That could
big effect because we not talking about the cost of our primary
affect whether gas prices keep falling. There are some impacts
fuel. We use oil as a backup to reduce performance risk.
of falling oil prices in some of the regional markets in terms of a
MR. MARTIN: Todd Carter, any effects?
reduction in electricity demand due to a slowdown in drilling,
MR. CARTER: I agree with what has already been said. The only
but that is on the margin and not a fundamental impact.
other effect I would add is the slowdown in new oil drilling is
MR. MARTIN: So no real impact. Scott Taylor?
freeing up workers who can help build our projects.
MR. TAYLOR: I agree with Grant Davis. I dont see any major
MR. MARTIN: Nazar Massouh?
impacts from falling oil prices. Within our industry overall, oil is
MR. MASSOUH: Not surprisingly, I am a bit of an outlier in this
not a major player. Some of the LNG export terminals that are
group. I believe low oil prices will have an impact. Whether it will
planned may suffer, as they may find it harder to find buyers
be severe, time will tell, as it depends on how long oil prices stay
willing to lock in prices under long-term contracts. Demand for
at $46 a barrel.
electric vehicles may suffer.
There are two primary areas where I see an effect.
MR. MARTIN: What about in New England where fuel oil is
One is on overall gas supplies. If oil prices remain as low as they
used more heavily than in other parts of the country?
are today, I get a little concerned
about a possible tightening of
gas supplies because of the loss
of associated gas.
The second effect is on electricity demand. A lot of the
growth in ERCOT, for example,
has been driven by the oil and
Close to 100,000 megawatts of coal-fired power
gas industry and new drilling.
Fortunately, Texas is a low-cost
plants are expected to be retired in the US.
oil producer, so perhaps we will
not see as much of an impact in
Texas. In places like Oklahoma,
Colorado and North Dakota, we
can see a greater effect. We live
in a world with less than 1%
annual growth in demand for
MR. TAYLOR: I dont know the New England market well, but
electricity. In such a world, a reduction in demand growth to
I believe oil is only on the margin in New England in January and
0.5% is huge. I can see some impact on power demand, particuFebruary, so consumers will benefit a little bit, but low oil prices
larly if the slump in oil prices persists for a while. On the other
should not have a big effect on the shape of the power market
hand, falling oil prices have led to lower gasoline prices at the
in New England.
pump, putting more money in consumers pockets and helping
MR. MARTIN: Joe Kerecman, you are nodding yes. You agree
the national economy to grow, so declining electricity demand
with Scott Taylor.
in some areas could be offset by additional demand in others.
continued from page 59

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MR. MARTIN: Does anybody in the audience see collapsing oil

prices having an effect on the independent power market?
Nothing? [Pause.] Thats news in itself.
MR. CARTER: I think that we in our industry tend to focus solely
on our industry and not think enough about the external factors.
Lets go back to 2007. What changed our industry is not that we
created a new, more efficient turbine or we were able to build a
natural gas-fired power plant more cheaply. What changed us is
the fact that the oil and gas industry figured out a way to produce
natural gas for a lot less.
I look at the renewables industry, and the same is true. What
introduced renewables into the world of power generation is the
technology improved so significantly that it brought down the
cost of utility-scale solar from $230 a megawatt hour to maybe
$80 today. That is huge improvement. I would like to challenge
all of us to think more outside our industry for trends that affect
us. Anyone building a power plant must think at least 10 or 15
years out. We have to because a power plant is a 30-year asset,
and some of these changes could have a significant impact on
the economics.
MR. MARTIN: Let me ask a quick question as a bridge to something else. Grant Davis, Nazar Massouh, you guys have money;
you invest in things. You three guys in the middle are developers
focusing on power projects that use natural gas. Are you two
guys with the money putting your money into gas-fired
MR. MASSOUH: The answer is absolutely.
MR. DAVIS: Yes and, in fact, Tenaska is on both sides of that
equation. We have money, and we are also developers.

Market Shares
MR. MARTIN: Next question. The independent power industry
seems to have peaked in terms of market share at about 42% of
US generating capacity; it hit that about 2003 and its market
share has not moved since then; the utilities are the rest. Many
people thought the utilities would start reclaiming market share.
Now the distributed generation companies come on the scene
and are asking for a share of the market. Who cedes market share
to them: the independent generators or the utilities?
MR. CARTER: There are more people on this panel that have
capital than what you just mentioned.

MR. MARTIN: Panda Power Funds! [Laughter.]

MR. CARTER: It depends. Somebody had data earlier today
showing that there will be a ton of distributed generation. If that
were a profitable business, I promise you we would invest in it.
I promise you Calpine and everyone else on this panel would
invest in it. We always look at new technologies.
MR. MARTIN: Lets drill down on that. You have companies like
SolarCity and Vivint growing at a 100% annual growth rates.
Some of the smaller companies are growing at 200% a year. Why
isnt that a good place to invest?
MR. CARTER: Listen, I like solar; we built a very large solar
project in New Jersey of all places. Why did we build it? We built
it because there are state regulations that give us an incentive
to build it. I am glad those companies are growing. We dont see
that as a big investment from our perspective, but we look at
things a little differently than they do.
MR. MARTIN: If the rest of you were starting over today or you
were just figuring out where to deploy capital, would you put
your capital into rooftop solar?
MR. MASSOUH: I am on the board of one of these companies,
Sungevity, and we made an investment. The investment was
backed by 20-year contracted cash flow from their existing
customers. We are not taking the risk that the solar rooftop
industry will continue to grow. Most of the rooftop companies
remain funded largely by venture capital. None of us is a
venture capitalist. None of us is paid by our investors to take
venture capital types of risks, so that is why none of us on this
panel would invest in these businesses. Will they make an
impact? Yes, but Scott Taylor said it well earlier which is that
they will make an impact up to a point. They will not replace
conventional independent generators. I have a lot of respect
for David Crane, but I disagree with his predictions about the
long-term direction of the industry.
MR. KERECMAN: There are three critical ingredients for rooftop
solar. One is a high retail electricity rate. Another is a sort of regulatory cram down of the net metering rules. The third is
You almost have to consider California separately from the
rest of the market. California is not representative of the larger
US. Is the distributed generation model taking hold outside
California? Im not so sure. Obviously New Jersey has a lot of solar
penetration, but solar insolation is not as good in New Jersey as
in California. To the extent distributed generation has taken hold
in New Jersey, it is really through force / continued page 62

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Current Trends
continued from page 61

feeding of a business model. Returning to PJM data for 2013, solar

accounted for just 355 gigawatt hours out of 797,000 gigawatt
hours in total.
MR. MARTIN: You are director of government and regulatory
affairs and tend to see through that lens. You dont think that
distributed generation works without government support. Todd
Carter, you appear to believe the same thing. You built a solar
project in New Jersey, but only because of the strong government
support. Is there anybody on this panel who thinks that distributed solar is where you would put your money if you were starting over today. Scott Taylor nods no.
MR. DAVIS: Our affiliate has done utility-scale solar. It is a challenging market for a private equity investor. There is another
player at the table.
MR. MARTIN: Who is the other player at the table?
MR. TAYLOR: The tax equity.
MR. MARTIN: So too many moving pieces; government is a big
part of it.
MR. TAYLOR: The returns are too low relative to private equity

A wave of utility mergers is not expected.

commissions try to extract concessions.

MR. MARTIN: Then lets move in a different direction. Tom

Fanning, CEO of Southern Company, sees a silver lining in that
demand for electricity will increase as the market moves to
electric cars. Will the collapse in oil prices put an end to that
MR. TAYLOR: I do not understand how electric cars were going
to be the cure for demand growth, even before oil prices

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collapsed. Even if electric cars reached 20% of the US auto

market, that would lead to only a 5% increase in demand. It is
not a substantial enough number.
MR. MARTIN: Isnt that a substantial number given how little
electricity demand is increasing currently: about .9% a year?
MR. TAYLOR: Over time. What is total US generating capacity:
about a million megawatts?
MR. MARTIN: A little over.
MR. TAYLOR: So thats 50,000 megawatts. That is a big number,
but it is not a game changer.

Utility Death Spiral?

MR. MARTIN: Next question. EEI, the trade association for the
regulated utilities, put out a paper a couple years ago that used
the words death spiral. The author saw the distributed generators picking off utility customers, not just any customers, but the
most creditworthy customers. Then rates have to go up for the
remaining customers to support the grid. Higher rates push more
people to distributed generation. Do any of you worry about a
decline in the creditworthiness of the electric utilities? After all,
as independent generators, they are your customers.
MR. KERECMAN: At some point, the cost of reliability has to
be assumed by somebody. You cannot put your solar panels on
the roof and expect the utility
still to be there if something goes
wrong. The fundamental system
has to come up with an answer.
MR. MARTIN: The regulators
will have to step in; solar customState utility
ers will have to pay more despite
not using the grid as much?
Nazar Massouh?
MR. MASSOUH: What we do
not spend a lot of time talking
about is that rooftop solar is a
peak shaving tool, and that is
pretty valuable to the utilities.
Granted, the generation is intermittent and unpredictable, but
I think the utilities tend to exaggerate the impact on them. If you
look at the history of operation even in California, which probably
has the highest penetration, utilities are getting used to distributed generation because rooftop solar is generally there most of
the time and probably easier to predict than it is to predict wind
generation. Look, utilities are not going away, and they definitely

will have to continue to provide generation of last resort directly

or by buying from independent generators.
MR. MARTIN: When utilities need more power, they may go
to independent generators for power. The distributed generators
sit on one side of the utilities picking off utility customers. The
independent generators sit on the other side looking to supply
those same customers through the utilities. The distributed
generators are growing rapidly. Isnt all the new load growth
being filled by the distributed generators? Todd Carter.
MR. CARTER: We do not see that much growth in distributed
generation. We pay attention to it of course, but we do not see
it. But, listen, we are not in every market either. We like PJM, and
we like ERCOT. We do not see as much distributed generation in
those markets as what you just described.
MR. MARTIN: You will find additional market share out of the
coal retirements or, if not, what else is creating opportunity?
MR. CARTER: I have never seen gas-fired power plants beat
coal plants so significantly as I see now. The reality is we are
putting some coal plants out of business. I am sorry for the coal
guys. I think they have more issues than the bare economics,
but that is part of life. You have to get more efficient in how
you do things.
MR. MASSOUH: Let me put some numbers around what Todd
just said. The reason we do not see the distributed generators
is when we got involved with Sungevity several years ago, it
was advertising it would double its installations from the year
before. It was going to double installations from nine megawatts to 17 or 18 megawatts. To your point, displacing a 1,000or 2,000-megawatt coal plant makes a difference. The growth
rates for distributed generation are very high in percentage
terms, but distributed generation is still having a very minor
impact on the industry.

Other Opportunities
MR. MARTIN: If you were starting over today, would a good place
to invest be conversions of coal-fired power plants to run on gas?
The last time I checked, coal accounted for about 38% of US
generating capacity. Retirements are expected to accelerate.
MR. KERECMAN: That may make some sense where the coal
plants are close to the gas supply. Conversion does not require a
huge investment. The coal plants probably also have a high heat
rate. Of course, you have to de-rate the plant when you make the
conversion, so it is probably more about a capacity play and then,
from a capacity standpoint, like I said earlier, the rules are changing, so the converted plant needs to be pretty reliable. These coal

plants are 40 to 50 years old. They were installed as base-load

resources. They have not been operating as base-load resources,
so they have been basically having to cycle. That makes them
even more unreliable. It is an interesting question, but, from an
efficiency standpoint, I wonder whether it is a great use of gas.
MR. MARTIN: Not much opportunity. Scott Taylor, agree?
MR. TAYLOR: I have a view, but it is probably self-serving, so I
think I will pass.
MR. KERECMAN: It probably makes sense for some of the
regulated utilities. The investment goes into rate base. It is fairly
easy to switch, but the plants are on the margin and these plants
are not made to operate as peakers, so the only value they really
provide is reliability in a capacity play.
MR. MARTIN: A number of years ago there were several
European utilities looking at a play in the US market at coal-fired
power plants. Do you see any merit to such a play today?
MR. TAYLOR: No. It is good to swim against the current sometimes and pick the contrarian view, but that is one play that I
would never think about tackling.
MR. KERECMAN: Are you asking about developing a coal plant?
MR. MARTIN: Just buying existing coal plants.
MR. KERECMAN: If you buy them very, very cheaply and have
a very short horizon in terms of how long you can use them,
then maybe.
MR. TAYLOR: I agree with that.
MR. MARTIN: Next question. Many people predicted, after the
Public Utility Holding Company Act was repealed in 2005, that
we would see a waive of utility consolidations. We have not seen
much, but recently Exelon bought Constellation and is planning
to buy Pepco. NextEra is buying Hawaiian Electric. Are we about
to see more consolidations?
MR. MASSOUH: That is a tough one to predict.
MR. CARTER: Apologies to my utility friends, but I think utilities
are a lot alike; they can be herds of sheep. If you start to see a
few acquisitions, then a lot more may be on the way.
MR. MARTIN: Larry Eisenstat, this is your area of expertise. Are
we about to see a wave of utility consolidations and, if so, why
now and not earlier?
MR. EISENSTAT: I do not foresee a wave of utility consolidations. There are significant regulatory hurdles. For one thing, the
local public utility commissions will try to extract whatever
consideration they can.
MR. KERECMAN: Mergers are hard to do.
MR. MARTIN: Next topic: energy storage. Many people think
energy storage will be a game changer, / continued page 62

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Current Trends

MR. MARTIN: Many of us are old enough to remember the last

rush to do merchant power projects that ended badly around
continued from page 61
2000 or 2001. Many of the bankers who financed the last wave
but no one has figured out how to make the economics work, at
of merchant plants are no longer working in the industry. Why
least as a standalone storage unit or by adding additional capital
is this a different merchant phase than we experienced before?
cost to an existing utility-scale renewable energy project. What
MR. CARTER: Today is completely different than the last round.
do you think is the future for utility-scale storage and, if it is a
For one thing, capital is not easy to come by. We have done $5
bright future, what is the path forward?
billion worth of projects, but not many banks were involved.
MR. CARTER: Judging from the fact that a lot of people in the
MR. MARTIN: Why is it a different marketplace?
audience just headed for the exit when you mentioned that, it
MR. CARTER: We are in the midst of a transition in terms of
kind of gives you an idea what most people think about storage.
market exit. The number of coal and nuclear power plant retire[Laughter.] Listen, if it worked, we would love it. We have lots of
ments is creating an opportunity to build highly-efficient new
wind in Texas that does not blow when you need it. It would be
power plants that burn cheap natural gas.
great if we could store the electricity. The technology is not yet
MR. MARTIN: Grant Davis, why do you think the current rush
to finance merchant power plants will end differently this time
MR. MARTIN: Does anyone see a path forward for storage?
than it did before?
Nazar Massouh?
MR. DAVIS: I am not convinced that it does end differently,
MR. MASSOUH: Batteries and energy storage are probably
quite honestly.
where distributed generation was about 10 years ago, so maybe
Our industry has a tendency to overshoot, and we cannot
at some point, but not in our investment horizons.
necessarily rely on the capital markets to be our discipline. Just
because someone will make money available to us does not
necessarily mean we should build. I worry about repeating the
MR. MARTIN: What are the most significant current trends in
same mistakes as in the past.
todays market? Lets start with Grant Davis and then move
MR. CARTER: Grant, I am sorry, but I disagree with you. The
across the panel.
only projects we are financing are ones where it is clear the debt
MR. DAVIS: The merchant generation model will probably
can be repaid. We have sold power forward and expect capacity
dominate things for the next two to three years.
payments over time that make us feel pretty good about being
able pay debt service. That is different than what happened the
last time. Not many quasi-merchant plants are being built this
time around.
MR. MASSOUH: I tend to
agree. I think three things are
very different than they were
back in the late 1990s. First,
Energy storage is where distributed generation
there are a lot fewer developers
and fewer capital providers. The
was 10 years ago.
independent power producers
who drove the growth and the
overbuild in the late 1990s are
hardly building. What remains

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are private equity-backed developers who tend to be a lot

more disciplined. Second, all these projects have a lot more
equity in them. Third, hedging is being used to reduce risk. All
of these projects are structured so that if you get the merchant-for-gas wrong, you are not immediately in default and
turning the keys over.
MR. TAYLOR: The market is a lot more disciplined than before.
I was around then, but I was not involved in any merchant projects, so I cannot do an actual comparison, but I do know that you
have to satisfy three parties today equity, debt and hedge
providers - before a project can be financed. All three are sophisticated, well aware of what happened the last time and determined not to see the experience repeated. A lot of due diligence
is done. A large cushion is built into the economics.
MR. MARTIN: Bob Simmons of Panda, do you want to add
anything? You are on the front line raising money for some of
these projects.
MR. SIMMONS: The industry had a Field of Dreams model
before 2000: build it, and they will come. Developers could raise
80% debt. They did not have to persuade other constituent
parties, like hedge providers, to participate. We have financed
three quasi-merchant power plants to date with roughly 50%
equity and 50% debt. It is pretty difficult to raise that kind of
equity and very difficult to raise that much debt on a merchant
or quasi-merchant basis. We have been able to improve on the
leverage, but only slightly and certainly not to the point where
we were 15 years ago.
MR. MARTIN: Grant Davis, can merchant plants be financed
anywhere besides in ERCOT and PJM?
MR. DAVIS: I would say no.
MR. MARTIN: Todd Carter, do you agree?
MR. CARTER: No. [Laughter.]
MR. MARTIN: Where else can you do them?
MR. CARTER: We are focused today on PJM, so I am being a
little tongue and cheek with Grant. ERCOT and PJM are clearly
the best markets.
MR. KERECMAN: I would add New England.
MR. MARTIN: The entire New England ISO area?
MR. KERECMAN: New England has come a long way. There has
been a lot of improvement in the market construct. New York is
a different story because of the amount of state intervention.
MR. MARTIN: So merchant plants work in New England. Scott
Taylor, what is another important current trend in the market?
MR. TAYLOR: This is not a current trend because it might take
another five years, but there will be a resurgence of long-term

power contracts or ISOs modifying their capacity programs to

be more than just one-year capacity markets. This will lead to
development of large-scale gas plants that are needed to satisfy
the projected demand over the next 20 years.
MR. MARTIN: Joe Kerecman, an important current trend?
MR. KERECMAN: I agree with Scott Taylor to a degree. In vertically-integrated areas like MISO, large-scale retirements of
existing coal-fired and nuclear power plants will hopefully cause
states to order utilities to enter into competitive-process PPAs to
acquire capacity rather than simply allowing them to self-build.
MR. MARTIN: Todd Carter?
MR. CARTER: I think we are living the dream right now. We are
building projects in places where the rates of return are high
enough to justify new construction. Cheap natural gas is changing certain markets more quickly than others. We are going in
with our eyes open and with lots of diligence around risks and
the projected returns.
MR. MARTIN: Nazar Massouh?
MR. MASSOUH: I agree with what was said earlier about retirements, but with a slightly different angle. I think we are learning
how to live with a lot less coal and, in some cases, less fossil
fuel-fired generation as is the case in NEPOOL. Reserve margins
are shrinking. It is possible to build again in NEPOOL, but most
new construction to date has been backed by contracts. It is not
possible to build in New York. Then I go all the way across the
country to California, which is its own animal. With all the renewable energy there and the retirements of nuclear generation,
California must figure out how to attract our capital because,
without private capital, California will be in for a shock over reliability of the power supply, among other things.
MR. MARTIN: Various people have said that the independent
power market is a boom-and-bust business. Each individual
generator has an incentive to maximize output, but if all generators do that, then the entire sector is eventually impoverished. It
is a little like the agricultural sector before the 1930s when target
prices and crop set-asides were adopted. Where are we on the
boom-and-bust continuum? We appear to be in a growth phase.
How much longer will it last?
MR. DAVIS: Another five to six years.
MR. MARTIN: Scott Taylor, do you agree with the premise? Is
this an industry that faces boom-and-bust cycles?
MR. TAYLOR: There are definitely ups and downs. However,
there is a lot more discipline in the market than the last time,
which will temper future ups and downs.

FE B RUA RY 2015




Environmental Update
The US Environmental Protection Agency missed a January
2015 deadline to finalize a rule to control carbon dioxide
emissions from new power plants. It announced, at the
same time, that it would also miss a June deadline to finalize
a corresponding Clean Power Plan rule to reduce emissions
from existing or modified power plants.
Although the two rules have been subject to different
comment periods and will be based on different provisions
of the Clean Air Act section 111(b) for new plants and
section 111(d) for existing and modified plants EPA
intends to defer completion of both to an unspecified date
in mid-summer.
EPA said that it will also simultaneously issue a model
implementation plan that it is developing for states to
follow as a guide to drafting their own state implementation plans for existing and modified plants. EPA could
impose the model plan on any states that fail to come up
with their own plans to meet CO2 emissions targets.
The agency said the delay is needed because new issues
have been identified that will have to be addressed by
better coordinating the rules covering new, existing and
modified plants.
EPA extended the comment period earlier for the proposed rule governing existing and modified plants to
December 1, 2015 and received more than two million
comments. The proposal would require states to reduce
carbon dioxide emissions from existing plants by 30% from
2005 levels by 2030. The delay may allow EPA to address a
number of predictable consequences in a more coordinated
fashion, including potential system reliability issues.
However, the move also appears designed to delay efforts
by Republicans in Congress to block the initiative.
Opponents argued that the rules will accelerate closures
of older, dirtier coal-fired power plants and essentially prohibit new coal facilities from being built due to the need for
expensive carbon-capture technology to meet the expected
standards. A number of states and industry groups have
already sued EPA over the proposals and other suits are
expected. A three-judge panel in the US Court of Appeals
for the District of Columbia will hear oral arguments on
April 16 in several lawsuits challenging whether EPA has



F EB RUA RY 2 015

authority to regulate carbon dioxide emissions from existing power plants under section 111(d) of the Clean Air Act
that been consolidated under the names In re Murray Energy
Corp. and Murray Energy Corp. v. EPA.
Congress is also expected to get into the act. The Senate
majority leader, Mitch McConnell (R-Kentucky), tried procedural moves to derail the existing plant rule in 2014 when
it was first proposed, but the effort was considered premature because the proposed rule was not final. Congress
could try to bar use of federal funds to implement the final
rule in a must pass spending bill that may be hard for
President Obama to veto without shutting down part of the

California Cap-and-Trade
The California Air Resources Board CARB, for short
decided in November that 88,955 offset credits in the state
cap-and-trade program are invalid. Each credit allows the
holder to emit one ton of carbon dioxide equivalent. The regulated entities that hold the invalid credits will have to buy new
credits or reduce emissions.
Utilities and other entities that are subject to the California
cap-and-trade program may use offset credits to meet up to
8% of annual compliance requirements. CARB has adopted
offset protocols for urban forest projects, livestock methane
digester projects as well as projects that destroy ozonedepleting substances and capture methane from mines. Offset
credits may be generated by these types of projects.
In May 2014, CARB notified holders of 231,154 offset credits
that it was investigating whether the credits are valid. The
credits were transferred into a special CARB account pending
the results of the investigation. They could not be sold or
transferred in the meantime.
The offset credits were generated by two separate offset
projects to destroy ozone-depleting substances at the Clean
Harbors incineration facility in El Dorado, Arkansas. CARB
regulations allow invalidation of offsets if the offset project
activity and implementation of the offset project was not in
accordance with all local, state, or national environmental and
health and safety regulations during the Reporting Period for
which the [CARB] offset credit was issued.

found in 37 states, from Maine to North Carolina on East Coast,

west to Oklahoma and north into the Dakotas, Montana and
Wyoming. White-nose syndrome is found in most areas where
the bats live, but is particularly severe in the northeast.
The Endangered Species Act prohibits any take, including
harming, harassing or killing, of endangered and threatened
species, unless a permit has been granted.
An endangered listing indicates that the species is in danger
of extinction in a significant part of the area where it lives,
while a threatened designation indicates the species is likely
to become endangered in the foreseeable future. If a species
is listed as threatened, the Fish and Wildlife Service may order
protective measures deemed necessary and advisable for
conservation of the species without unduly burdening persons
with regulations that do not further its conservation.
In areas of the country affected by white-nose syndrome,
companies would still be allowed to engage in forest management practices, maintenance and limited expansion of transNorthern Long-Eared Bats
portation and utility rights-of-way, removal of trees and brush
The US Fish and Wildlife Service said in January that it is conto maintain prairie habitat, and limited tree removal projects
sidering listing the northern long-eared bat as threatened
if these activities protect bat maternity roosts and hibernac rather than endangered under section 4(d) of the
ula. The strongest restrictions would apply during the twoEndangered Species Act.
month pup-rearing season in June and July when the bats
The Fish and Wildlife Service first proposed listing the bat
occupy their hibernacula and are most vulnerable. Incidental
as endangered in October 2013 after finding there has been a
takes of bats would be allowed, without the need for permits,
severe decline in the species due to white-nose syndrome, a
in parts of the country that are not affected white-nose
fungal disease affecting cave-hibernating bats. The bat is
Various energy and timber
groups argue that an endangerment listing would
severely harm their industries
and have been pressing for
the less severe threatened
listing. However, the proEPA is expected to release a model implementation
posed rule may offer only
limited relief compared to an
plan this summer for states to reduce carbon
endangered listing because
it would not exempt
emissions from power plants.
/ continued page 68

FE B RUA RY 2015




CARB did not question whether the offsets were real, quantified or verified. Instead, it invalidated the 89,955 credits
associated with one of the two destruction projects because
the El Dorado facility was alleged to be in non-compliance with
the federal Resource Recovery and Conservation Act. CARB
determined that the other 142,199 offsets were created during
destruction of ozone-depleting substances that were generated after the alleged violation was cured.
CARB said Clean Harbors failed to dispose of the waste after
destroying ozone-depleting substances as a hazardous waste
in violation of the law. Clean Harbors was not in compliance
for two days in early February 2012. Clean Harbors entered
into a consent agreement with EPA in April 2014 that settled
these as well as other alleged violations at the facility.
Future purchasers of credits should weigh the risk of invalidation when negotiating to purchase credits and consider
obtaining insurance to cover the risk.

Project Finance NewsWire

Environmental Update
continued from page 67

incidental takes associated with wind, solar, mining, construction, agricultural and oil and
gas activities.
The Fish and Wildlife Service has extended the time to April 2, 2015 to make a final decision about how imperiled the bats are currently. The latest proposal appeared in the Federal
Register on January 16, 2015. The public comment period runs through March 17, 2015.

contributed by Andrew Skroback in Washington

is an information source only. Readers should

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please contact our editor, KeithMartin, in
Washington (kmartin@chadbourne.com).
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F EB RUA RY 2015